Cushioning Losses With ETFs

As the markets continue to witness enhanced volatility and uncertainty, exchange traded funds (ETFs) which employ options as a way to hedge bets can provide insurance and additional income.   

These ETFs generally hold stocks while writing call options against their respective index, which enables one to have somewhat of an insurance policy against a downward spiraling market.  Additionally, these ETFs generate income when they sell their calls, which could dwindle away losses generated from a falling market.

Although these ETFs offer hedges against a falling market, a way to reduce risk and a means of additional income, they have their drawbacks as well.  In a stable and fast growing market, these option employed ETFs generally do not fare well.  In fact, these ETFs work the best in choppy markets and are likely to underperform when volatility is low and investor confidence is high.    

Some of these ETFs include:

  • PowerShares S&P 500 BuyWrite Portfolio (PBP), which holds companies like Exxon Mobil (XOM), Microsoft (MSFT) and Proctor & Gamble (PG) while writing call options against the S&P 500.
  • PowerShares NASDAQ-100 Buy-Write (PQBW), which provides exposure to the tech-heavy Nasdaq 100, including holdings and call options in Apple Inc (AAPL) and Google (GOOG).
  • iPath CBOE S&P 500 Buy-Write Index ETN (BWV), which is a senior unsecured debt security that gives exposure to the CBOE S&P 500 Buy-Write Index.

In a nutshell, given the current market environment, any form of insurance is a good idea. Options, specifically covered calls, can offer a downside or sideways cushion against losses and volatility and the aforementioned funds offer an easy way to add buy-write insurance to your portfolio.

Disclsoure: Long PBP

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