ProShares jumped into the covered call fray with its S&P 500 High Income ETF (ISPY). That is some symbol. The point of differentiation for ISPY is that instead of selling calls with a monthly expiration it sells calls out of the money with a daily expiration (0dte). Defiance ETFs has three funds that sell 0dte puts.
The volume generally for 0dte options is very high. If someone buys 0dte options, they are speculating, it doesn't make sense to me that buying a put that expires in a few hours is really a hedging trade versus making a simple bet that something will fall, of course greed plays a role here. Selling to speculators is generally accepted as being less speculative which is the case until it isn't which is during the occasional, catastrophic blow up. Bloomberg's Eric Balchunas coined the phrase Volmageddon to describe incidents when shorting volatility blows up.
There hasn't been a catastrophe for shorting volatility since 0dte's became popular but if that happens, it's not yet clear to me what that would look like for 0dte's because they start to trade at the open with the change from yesterday already priced in. If there is another flash crash like 2011 or 2015, there was a lot of ground gained back before markets closed on those days. 0dte's would have also recovered and expired if they had existed back then. I'm not saying selling 0dte's can't blow up, they can, it just isn't clear what it would look like. Where ISPY is selling covered calls, then a blowup seems unlikely, lagging by a lot seems like the bigger risk. The Global X S&P 500 Covered Call ETF (XYLD) has been around since 2014 and while it has lagged the plain vanilla S&P 500 badly, its annualized total return is still 5.78%.
ProShares appears to be saying that by selling daily options, it will allow the underlying equities to capture more upside than selling monthly calls like XYLD. If you remember something called the night effect, apparently most of the gains for the S&P 500 over the last 30 years came between the close and when the market opens the next day. So like if the S&P 500 closes one day at 4421, opens the next day at 4430 and closes that next day at 4432. Most of the gain would have been overnight. The data on that is clear, Bespoke Investment Group talks about it every so often, but there was an ETF that tried to capture that effect and whether it was bad timing or something else, it lagged badly and closed. But if the night effect is real going forward, then ISPY would capture it in a way that the other covered call funds don't.
If covered call funds are less volatile than plain vanilla equity indexes then ISPY might be giving that attribute up as a tradeoff for capturing more upside. I don't know, we'll see but it's an interesting idea and I will watch it.
I wrote the above on Dec 20, the day markets closed down about 1.5%. In real time there seemed be no reason cited for the decline. Starting the day on Dec 21, there's content from Bloomberg and Unusual Whales that 0dte's were to blame. They cited a surge in natural volume (customer trades) leading to a corresponding surge in hedging by liquidity providers. In the face of that, ISPY was down less than the S&P 500 but its last trade was 3 minutes before the close. QQQY (personal holding that I am test driving) was down much less than the S&P 500 and the Invesco QQQ Trust, JEPY was down less than the S&P 500 and IWMY was down less than it's corresponding underlying iShares Russell 2000 ETF (IWM).
As a first test maybe, these ETFs did just fine. Does that tell us anything about a more dire single day market event? Probably not but that these didn't automatically crack and drop 5% in a down 1.5% world is a good first impression. If the sell off was "exacerbated" by 0dte's as mentioned in the Bloomberg article, ok but down 1.5% is not a catastrophe and the funds in question held up a little better. If 0dte's are going to create more of these types of days but the funds don't do worse (yesterday they did better) then that wouldn't be the funds' problem and not in an of itself a disqualifying factor. There might be other disqualifying factors, but maybe not adverse single days. I would also note that all four 0dte ETFs opened higher on Thursday along with the market, so no delayed effect from Wednesday's decline.
When I first tried to navigate to the page for ISPY, I went to SPDR's website instead of ProShares which sent me down an interesting rabbit hole looking at SPDR's model portfolios. They build out a few different types with various allocation percentages for each type. I was curious of course so I looked at the 60/40 blend under Strategic Asset Allocation.
Portfolio 2 below is the Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 portfolio and Portfolio 3 is 60% iShares All Country World Index ETF (ACWI) and 40% in SPAB.
VBAIX' outperformance is most likely due to its being domestic equity only which is why I included ACWI in Portfolio 3. For all the work that went into SPDR's portfolio and there was work done, the study period is long enough and there's been enough different types of market drama to feel confident that this is just a market-equaling portfolio that would be far more complicated to follow than just ACWI/SPAB. Complexity for complexity's sake. There's nothing from the back test to suggest the SPDR portfolio will ever meaningfully outperform either nominally or on a risk adjusted basis. Market-equaling isn't necessarily bad if that is a long term result but the SPDR portfolio tracks every up and down as opposed to something like a path to the same result with lower volatility which would be a desirable outcome.
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