The PowerShares S&P 500 BuyWrite Portfolio(PBP Quote - Cramer on PBP - Stock Picks) and the PowerShares Nasdaq-100 BuyWrite Portfolio(PQBW Quote - Cramer on PQBW - Stock Picks) are all-weather ETFs.
The funds provide investors with positive returns in up markets and outperform in down markets.
The concept behind these BuyWrite ETFs is that they invest in the stocks contained in the S&P 500 and the Nasdaq-100 indexes and then write covered calls against those shares every third Friday to generate additional income.
The calls that are written, which have about one month until expiration, are held until expiration and cash settled, at which time new one-month calls are written.
"You are selling the calls just out-of-the-money," says Matt Moran, vice president at the Chicago Board Options Exchange. "In doing so, you are taking in a tremendous amount of premium income."
For PBP, writing calls can cut short rallies in holdings on the upswing, such as Bank of America(BAC Quote - Cramer on BAC - Stock Picks), Citigroup(C Quote - Cramer on C - Stock Picks) and Wells Fargo(WFC Quote - Cramer on WFC - Stock Picks). The fund can compensate for that by limiting declines in plummeting shares, including American International Group(AIG Quote - Cramer on AIG - Stock Picks), Apple(AAPL Quote - Cramer on AAPL - Stock Picks) or Intel(INTC Quote - Cramer on INTC - Stock Picks).
The CBOE S&P 500 BuyWrite Index(BXM Quote - Cramer on BXM - Stock Picks), which PBP tracks, was launched by the CBOE and Standard & Poor's in 2002. It resulted from a study by Duke University professor Robert Whaley that analyzed the results of a buy-write strategy from June 1998 through December 2001.
The CBOE has since updated data on BXM to demonstrate how it would have performed from July 1986 through August 2008. According to the CBOE and Bloomberg, $1 invested in BXM in July 1986 would now be worth $8.87. One dollar invested in the S&P 500 would have returned $8.55 over the same period. As for bonds, 30-year Treasury bonds would have yielded $4.61 and 3-month Treasury bills would have turned into $2.72.
In 2006, Callan Associates, an investment-services consulting firm, published a new study that built upon Whaley's previous findings. The Callan study found that BXM did lag the S&P 500 during most rising equity markets from June 1998 through August 2006. However, the index consistently outperformed the S&P 500 in all declining equity markets as it benefited from premium income.
"For investors looking to have a broad exposure to the market, the BuyWrites are an interesting way to get it," said Ed McRedmond, senior vice president of portfolio strategies for Invesco PowerShares.
The buy-write strategy has proven to be particularly effective in recent bear markets. "The index had a run of six straight months of outperformance versus the S&P 500," Moran said of BXM's returns from October 2007 through March 2008.
Year to date, PBP is down 9.9%, while the S&P 500 has dropped 19.1%. PQBW, on the other hand, was just launched in June. As long as the broader markets continue to struggle through current headwinds, the BuyWrite ETFs might continue to shine. "If you are interested in smoother returns, this might be a strategy to consider," says Moran.
