Inevitably someone will bring up the BuyWrite strategy when discussing portfolio management. Managing this strategy manually from a lazy portfolio perspective would likely increase management time 100-200% easily. It would also increase transaction costs significantly as well. About one year ago (6/26/2007)
I wrote about the new ETF being offered by Barclays that tracks the CBOE S&P 500 BuyWrite Index (technically an ETN). PowerShares has also introduced their own take. It has the ticker symbol PBP. Again, one of my favorite things about building strategies into ETFs is that it's very easy to prove or disprove these theories because they're very clearly shown in practice in the form of price movement. Oh, and if you're not familiar with the concept of BuyWrite, it's simply a covered call strategy where when the stock is purchased a simultaneous out of the money call is written. The idea here is to provide "income" when the stock or index goes nowhere and provide some downside protection in the form of premium from the call. The risk is that the stock or index rises rapidly and your stock is called away and you receive little of the rapid upside appreciation. Typically for an index, you don't see it rise 10, 20, 30% in a month, so the limited upside risk is more appealing.
Anyway, this is a great time to test the theories put forth by the BuyWrite proponents. The market has been down this year overall and really meandering over the last couple of months. I know it feels like the moves have been dramatic, but look at a chart and you'll see we're still bouncing about in a range. So how is one of the BuyWrite ETFs performing?
(click for full size)
As you can see, as of June 16th 2008, the BuyWrite strategy is break even for the 12 month period where the SPY (S&P 500) is down 10%. What's also quite notable here is the significant decrease in volatility with the BWV. Looking at this chart, I'm reminded of the old cartoons where the big bull dog walks strong and with purpose down the alley with a little yip dog bouncing over, under and side to side making a lot of noise and constantly seeking the big dog's approval. The BuyWrite strategy here is the big dog with its eyes on the goal and not much else. It typically goes without saying that noise reduction is welcome in any do-it-yourselfers portfolio.
Here's the rub though. The volume on both the Barclays and PowerShares ETFs are ridiculously low. BWV probably shows a bit more volume than PBP and you can see from my screenshot above that the volume on 16th of June for the entire day was 700 shares. This is common and presents a problem. This will likely mean large spreads which essentially increase your costs to get in and out of this position. If you're a DCA guy/gal, this cost will continue to add up over time. The second problem is that I've cherry picked a good market condition for BuyWrite. I didn't do this on purpose, it's simply the data I have to work with at this point. Whenever the next bull runs, it will be interesting to see how much the BuyWrite strategy underperforms. The second item is not so bad. It's nice to have some zig when your portfolio is zagging and vice versa. But until the volume picks up, I'll not be adding these to my long term holdings. They are on my watchlist though.
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