Barron's Takes A Look At Call Writing Funds

Call writing funds, or options strategy funds more broadly, is a space we've looked at quite a few times over the years. I used one call writing fund back around the Financial Crisis. For a short while, I've had a fund that sells out of the money puts, very far out of the money, for clients and personally. With the call writing funds I'm more of a follower of them than a user of them. There's one fund I've been test driving for possible use for clients since last summer and while it has done fine I have not added it in and I am not sure if I ever will. Here's the link to the Barron's article.

BXM is the S&P 500 Monthly BuyWrite Index and GSPC is the S&P 500. Almost 20 years is a good sample size. For much of the period studied, it was back and forth as to which one was the better performer. As the S&P 500 went parabolic for a bit to the right of the chart, BXM did not keep up. Play around with the chart yourself and you'll see some stretches where BXM outperformed by a lot. Whether BXM is outperforming or lagging, it seems to always be less volatile. That's pretty much the idea, covered call strategies are generally intended to reduce volatility and bring in some income. 

In 2022, BXM was down 11% versus about 19% for the S&P 500. If you look at decent sized sampling of funds in the space you'll see a wide range of results but every one of them that either tracks the S&P 500 with some sort of buywrite index or is actively managed was down less than the S&P 500 last year which is what the typical person buying one of these would hope for.

If you need normal stock market growth for your long term plan to work (that's most of us), based on the last 20 years, would you have gotten enough of the market effect if you owned a fund that tracked very closely to BXM? No wrong answer, it's up to you, would that have been enough. Would some sort of repeat over the next 20 years leave you with enough? 

Lower volatility is certainly appealing on some level especially with 2022 still fresh in our memory. For a lot of people, 2008 might still be fresh. 

A snippet from Barron's cited an objective of one of the funds as trying to capture 75% of the upside of the market and 65% of the downside. That might ring a bell for longtime readers as being similar to 75/50 that we've looked at many times before whereby a portfolio seeks 75% of the upside and 50% of the downside. That is hard to engineer, I would say liquid alternatives need to play a role to help by virtue that some of them are designed to go up when stocks go down.

Some covered call fund could do something like 75/50 or 75/65 or whatever in some random period but the variability of path dependency makes that difficult to rely on. More vaguely, being willing to accept less upside in order to have less downside is, I think, achievable even if specific numbers would be a matter of luck. 

 

For the last five years, BXM was quite a ways below 50% of the upside. In the Pandemic Crash of March 2020, BXM went down about as much as the S&P but couldn't get anywhere near the snap back. If the market crashes, a covered call strategy won't help, that's important to understand. When the crash snaps back as so many of them do, the calls sold might cut off that snap back as I think happened in 2020. An actively managed fund might be able to better participate in any sort of post crash snap back or depending on the constraints of the index underlying an ETF maybe that could fare better than BXM in that scenario.

That kind of paints a picture of the drawbacks of the strategy; can lag market cap weighting for long periods, not crash proof and the perfect storm crash scenario can mean it gets left far behind. That's not a reason to avoid them altogether though. BXM has years of outperforming and staying even with less volatility. I think that is an argument to not use them as the core equity holding though if you are in the majority of people who do need to capture the equity market's long term growth.

Could they play the same role as a minimum volatility or low volatility ETF? Yeah, maybe. That would come down to composition, rules and strategy and even then, no matter what someone might pick, no fund or strategy can always be best, they can be useful but there will be drawbacks. Don't tunnel vision on just the positives of whatever you do or choose, make sure you understand the negatives so you don't get blindsided or even worse, panic.