There’s no denying covered call exchange traded funds generated significant momentum over the past several years. With Treasury yields poised to decline as the Federal Reserve lowers interest rates and with the S&P 500 sporting a dividend yield of just 1. 17%, it’s reasonable to surmise that more income-hungry investors will pile into options writing strategies, including ETFs.
The bulk of the choices available in options ETF realm are covered call funds, meaning the issuer or a partner is selling call options on the fund’s underlying securities or an index such as the S&P 500 or the Nasdaq-100. Selling or writing call options is one of the more basic income-generating strategies, but in the name of eye-catching yields, some issues ratchet up that proposition. They roll out complex options-based ETFs with tantalizing yields that often subject end users to significant net asset value (NAV) erosion.
To be fair, many covered call ETFs are tame and function as expected while offering investors significantly higher yields than what they find with stocks and bonds.
However, there are more than covered call funds and that’s a good thing because put writing – the other side of the coin with covered calls – offers an attractive alternative in the options ETF space. Enter the WisdomTree Equity Premium Income Fund (WTPI).
WTPI Has the Goods
One of the potential advantages of an options-selling strategy such as WTPI is that investors have exposure to sources of returns: interest income through T-Bills and the income earned from selling options, the latter of which may increase as market volatility does the same. To its credit, the ETF features some attributes that are unique relative to old guard counterparts.
Furthering the case for WTPI, beyond a distribution yield of nearly 12%, is a simple point: data indicate that in fund form, put writing is superior to covered calls.
“Over long periods, selling puts has historically produced more income and more return than selling calls,” notes Christopher Gannatti of WisdomTree. “The reason why comes down to human behavior, market structure and the timeless tendency for investors to overpay for protection against the thing they fear most, a crash. ”
Even with that clear benefit, ETFs such as WTPI are unheralded relative to covered call rivals. As Gannatti points out, that’s a symptom of covered call strategies being familiar and easy to explain to end users. He says covered calls are akin to being a landlord while put writing is like being a property insurance provider. What many newbie investors don’t realize is that collecting insurance premiums is actually more lucrative than being a landlord.
“That's the core of put writing: you are selling downside insurance to the market and insurance buyers consistently overpay,” adds Gannatti.
Think of Put Writing in Psychological Terms
With put selling and ETFs like WTPI, there are elements of behavioral finance to be considered. In simple terms, out-of-the-money puts are often more expensive than call options in a similar state because investors are more fearful of losing money than they are optimistic about being profitable. It’s just human nature.
As Gannatti observes, this creates a volatility skew allowing put sellers to harvest bigger premiums than their call-writing counterparts. On a yearly basis, the volatility skew can play out in the form of a 1% advantage in favor of an S&P 500 put writing index. No big deal, but over many years, that 1% per year really adds up, indicating WTPI is a credible addition to income portfolios with long time horizons.
“One percent may not sound like much, but compounded over decades, it's the difference between an investment that feels ‘income-generating’ and one that's genuinely wealth-compounding,” concludes Gannatti.
