The new U.S. Equity High Volatility Put Write Index Fund
(NYSEArca:HVPW) from ALPS is only the latest ETF that explicitly
uses options in its strategy.
HVPW is perhaps the boldest and most explicit derivatives-based
income play in an ETF wrapper to date.
The fund explicitly aims for a 1.5 percent distribution every 60
days. That's roughly 9 percent a year if things go well-a pretty
enticing goal in today's next-to-nothing yield environment.
But for the average investors who's maybe not an expert in
options-and I'd include myself in that camp-the fund's strategy is
a lot to digest.
Naked puts. High volatility. Holdings that aren't intuitive. A
Let's break down these elements one at a time.
HVPW "writes" put options on each of 20 stocks, selling the
right to buy stocks at roughly 85 percent of their price at the
time. Investors who buy these "out of the money" options would
exercise them if the stock's price falls below that strike price
within the 60-day term of the option.
Hence the fund is on the hook for each of its 20 names for the
difference in price below a roughly 15 percent drop. As these
options are "American style," the investors who hold the options
can exercise them if the stock price drops below the strike price
any time during the 60 days.
In return for providing this insurance-putting a floor under the
stock price by writing the option-the fund collects a premium.
The premium affects the breakeven math for each stock.
Let's say the stock costs $100 at the time the option is
written, the strike price is $85 and the option costs $1. For this
hypothetical stock, the fund would start to lose money if the stock
price falls below $84 rather than $85.
The premium is of course the whole point-it's the engine that
provides the stated goal of 1.5 percent distributions at the end of
each 60-day period.
The puts sold by the fund are naked, meaning they're not hedged
by offsetting positions. This means the fund's exposure to
downside-below the breakeven point-is the same as if you owned the
While that sounds reasonable, consider that the fund's maximum
downside in the hypothetical stock above is -$84 while its upside
HVPW chooses options on stocks with the highest volatility.
A stock's volatility affects the premium of the option on the
stock:Higher volatility means higher premium. This makes intuitive
sense in that the strike price is more likely to be breached in the
case of stock with a wildly swinging price compared with a sleepy
name whose price rarely moves.
In this sense, HVPW's exposure to volatility is negative-it's
volatility rather than having positive exposure to it.
High-volatility stocks will command higher premiums precisely
because they're more likely to be exercised at a loss to the
This risk and reward of the premiums is tempered significantly
for strike prices that are 15 percent out of the money.
The fund's holdings don't reflect its exposure intuitively.
That's not a slight on the HVPW's issuer, ALPS, but simply the
nature of the beast.
The 101.5 percent cash position is almost entirely collateral.
This is an important point:The fund does not employ leverage as
many options investors might expect.
For many, the whole point of using options is to get more
exposure with less capital. For example, if you think that Google
stock will shoot up soon, you can buy a share for, say, $832. Or
you can use that same $832 to buy multiple call options to increase
your upside potential.
HVPW doesn't use this kind of leverage. Its cash stake is
roughly equal to the aggregate exposure of the strike prices of its
The economic exposure therefore isn't easily summed up in a
The downside exposure is proportional to long positions in the
underlying stocks at their breakeven points. The upside exposure
equals the premiums received with some possible capital gains from
stocks that moved below the strike.
New funds like HVPW don't have performance history, but often
track existing indexes that do.
In this case, however, the fund's underlying index itself is
also new, making performance comparisons impossible. The fund's
fact sheet shows a one-year performance chart, but the data on
Bloomberg and on the index issuer site starts about five weeks
That's a shame. Options and other derivatives have nonlinear
return patterns. And while put-writing strategies are hardly new,
I'd want to see something like a five-year series based on this
exact methodology, not a five-week pattern.
For conservative investors like me, the lack of a lengthy
history is a deal-breaker, but we'll see if HVPW catches on.
Funds that produce income-or at least try to-have attracted lots
And at least one other options-strategy fund, PBP, has
established itself with a long track record and assets of more than
$235 million, according to our numbers.
In fact, I had hoped to compare HVPW's index with that of PBP
since they should have similar return patterns-for reasons I won't
go into here-but the lack of an index history for the ALPS fund
At the time this article was written, the author held no
positions in the securities mentioned. Contact Paul Britt at
Permalink | 'copy; Copyright 2009 IndexUniverse LLC. All rights
Don't forget to check IndexUniverse.com's ETF Data
2013 IndexUniverse LLC
. All Rights Reserved.