Anyone using a Buy-Write Closed End Fund?

[Olav23]

Hi again all,

In a sideways moving market much like today, I'm wondering if anyone has put "money where there mouth is" in the direction of a Buy-Write strategy. There are quite a few Closed end funds that I have found that attempt to either emulate the CBOE Buy Write Index or go on their own more "hedge fund"-ish path. I'm considering a run on a CEF called "MBS" which I learned is a Morgan Stanley Covered Call CEF that mimics the BXM as closely as I can find.

There are a few others:
ETB MBS MBJ BEP

But after a bit of bigchart.com, it looks like MBS is built to correlate as closely as possible to the SP500 Buy Write Index.

Info on MBS:
http://www.financials.com/c/info/story.cfm?storynum=1157569


This article talks and links to a Ibbotson study on the BuyWrite:

http://www.thestreet.com/_yahoo/options/stevensmith/10213251.html

the most intriguing summary is:

The study showed that over the past 15 years, the BXM has delivered a compounded annualized return of 12.39%, slightly better than the SPX's 12.20%, but with 34% less volatility or market risk. As a purely passive investment program, it has produced superior returns while simultaneously reducing the risk by one-third. As of Monday's close, the BXM is up 1.7% year to date, while the S&P 500 is up just 0.04%. One drawback of covered-call strategy is that it greatly reduces the upside potential; in those years that the SPX has gained more than 18%, the BXM has underperfomed by an average of 6.5% per year. But this has been more than offset over time, as the BXM outperforms the SPX during down or flat years.


So, in theory you miss the huge upswings for a more reliable less volatile "dampening effect"

Any comments? Besides for the fact that its a CEF which can have the premium/discount risk, why wouldn't someone use this in place of the SPY or unhedged S&P500 fund?

 

[LOL!]

I'll dispute your premise that this is a sideways market. One question: What is the return on IWM for the last 3 months?


Covered calls are OK, but you have to pick them carefully. They limit your upside significantly in my experience. This is also mentioned in the article.

 

[Olav23]

Just to be clear, the Buy-Write is based on the SP500 not the Russell 2000(IWM). The 2000 has certainly performed better in the past couple of years than the 500.
Looking at YTD, both are up between 2-6%. 1,3 Year is a much better picture. But pull it out to 4 years and the IWM is up 40% and 500 is up about 4%. So, 4% over a 4 year time frame, (and this is absolute percent, not 4% yearly) I'd argue is sideways

I guess anyone can argue about directionality depending on your time frame...  But to me this still seems like an exciting product. I'm wondering what the "catch" is because it seems almost too good to be true to me.

http://www.cboe.com/micro/bxm/pricecharts.aspx

BXM vs S&P500 over 3 years (easy to see volatility reduced, but appears to have 2 bad data points that mess up the chart)
BigCharts link shortened by moderator Nords to keep the text on most monitors without scrolling.

Most of the US invests a large portion of their nest eggs in the S&P 500 either through a fund or ETF, generally as the benchmark of LC and proxy for the US market. Many people in the 20-30% of their portfolio range, I would assume if get portfolio advice from the many planners or online brokerage "portfolio planners". 

So, a product that removes  quite a bit of volatility while still remaining quite a bit of upside potential? Sounds like a win-win to me. What am I missing?

As far as picking your covered calls appropriately, the Buy-Write index is a completely mechanical system. It sells the first AT THE MONEY call on the S&P500 I think a month ahead expiration. So, there is no management whatsoever.

Mentally, I would assume the upside gets relatively close to the upside of the S&P because during very fast movements in either direction, option premiums would go up in value due to the volatility change and works in both ways (but always to the upside). So, if the market goes up quickly suddenly, the volatility would go up and the option premium would go up. Likewise, in a sudden down market, volatility would also go up and option premium would go up. Just my intuitive  opinion...

I guess I just wonder why I don't hear more about this in general.

 

[lazyday]

I haven't read much about this, decided to stop looking into covered call type strategies when it seemed to me that increasingly large amount of money is chasing the strategy/ies.
My suggestion is to look into how popular it is becoming (new mutual funds, growth of old ones like Gateway fund, any options data that helps, anecdotal evidence of how many are selling strategy secrets to the masses) and consider if it matters for future profits.
I think there's been other threads in this forum on covered calls, not sure if exactly the same strategy.

 

[LOL!]

I wonder if there are some problems in this strategy that are hidden by just picking a couple of time periods.  For example, if you lump-summed into BMX and VFINX, maybe BMX comes out ahead after awhile, but if you are DCA'ing into these, would VFINX come out ahead because of buying occasionally at lower prices?

Also there is the drag from commissions on the options.  You just can't get something for nothing.

As a side (bottom) note: I have sold covered calls for few years now.  Profits there are neither easy nor routine.   I think one reason for this is that folks don't like to give money away, so they neither buy nor sell options that are not fairly priced.

 

[LOL!]

I forgot to mention the tax consequences. For all those 1-month writes that expire worthless -- those are taxed as ordinary income. I would suspect that any advantage of BXM would be taxed away.

 

[Olav23]

Yeah, I forgot to mention the tax point. I planned on doing this in a tax advantaged account (IRA). This would definitely not be a good fund to stick into a taxable account unless you are at a very low tax bracket. Points noted on the added costs of a fund trading options. Not really sure since I can't find that information anywhere. I'm not even sure how this fund in particular (MBS) actually trades the BXM index. Its quite possible they use some synthetic product to emulate the index or even take other bets themselves and just pay out the BXM since I see that strangely the MBS has a date that it "matures". I wonder if matures means expires.

From the prospectus:

The new securities were issued at a price of $10.00 per unit with a maturity date of December 17, 2009.

The new securities are issued by Morgan Stanley and trade under the symbol
MBS. Beginning in June 2007, the issuer will have the right to redeem the
securities for mandatory exchange in whole, but not in part, on any exchange
date for a cash amount equal to the Net Entitlement Value determined on that
particular exchange valuation date.

I'm not entirely sure what that means. I can call my brokerage after Jun 2007 and have it "converted" to cash, as opposed to selling it in the marketplace? Very strange...

 

[ERD50]

Olav23 - The fund looks OK to me. Less volatility than S&P500 and similar (if not better) returns. LOL! makes some good points, but I'm just a tad more optimistic. I've been doing reasonably well with covered calls, but it is a fair amount of work to find attractive plays, and it takes a fairly big account to keep commissions reasonable and also diversify across 10 or so stocks. And I don't make a killing, and never will. With the covered call, you limit your upside, but the flat and down periods are biased slightly in your favor (by the premiums from selling the call).

I had trouble even finding where to download a prospectus on the Morgan-S web site, so I don't know about this 'conversion' thing. I think maybe it just gives them the right to cash you out of the fund, if they decide they don't want to offer it anymore (I would think the 'issuer' refers to M-S?).

But anyway, I think it is tough for a mutual fund to do covered calls effectively. They need to stick with these very large and liquid indexes/options. An index will have lower volatility than the individual stocks, so it kind of waters down the whole approach. But, it does look like they achieve their modest goal, and that can add up over the years.

I think it is worth considering, as always, do your research and assure it meets *your* goals - no one else can answer that question.

- ERD50