DAVID ROEDER droeder@suntimes.com January 15, 2012 1:40PM
Article from Chicago Sun Times
Updated: January 15, 2012 6:51PM
At the Chicago Board Options Exchange, the main operating unit of CBOE Holdings (CBOE), traders and corporate types know that the most important generator of business is market volatility. Volatility means revenue to the exchange, and opportunity and danger to traders.
So the CBOE has invented ways to measure volatility, coming up with the so-called “fear index,” the VIX, that now gets quoted routinely in market wrap-up stories. But volatility isn’t every everybody’s cup of joe, so the exchange also is behind ways to protect investors from it.
Its most successful products in that regard are its “buy-write” indexes that apply to the major benchmarks of U.S. stocks. The effort has spawned funds that use the buy-write strategy of combining stocks with issuing call options on them, thus generating income. Call options, remember, confer the right but not the obligation to buy a stock at a specified price by a specified date. The buyer profits if the stock rises. In that event, the seller could miss out on potential gains.
Last year, the strategy worked well, as CBOE Chairman William Brodsky noted to me last week at the annual luncheon he hosts for reporters. He suggested I write about it as an Everyman’s investment idea, an accessible way to get the benefit of options. Your humble correspondent is taking the suggestion while adding cautions.
In last year’s stock market of wide swings and little net change over the 12 months, the buy-write or covered call strategy worked well. Wheaton-based PowerShares runs the largest exchange-traded fund that uses the technique for the S&P 500, and it reported a 4.21 percent gain for the year. The fund has a ticker symbol PBP. The Fidelity Spartan 500 Index Fund (FUSEX), in contrast, gained just 1.98 percent.
So Brodsky is right about covered calls as opposed to just owning the stock, as least for 2011.
And that’s the kicker. It’ll work when markets are down or sideways. But if markets are moving higher, it will cut into gains.
PowerShares’ PBP fund, for example, has a three-year record of underperforming the S&P 500 index, 12.12 percent vs. 14.12 percent, according to fund disclosures.
“They can be used to create income but they also can go awry very quickly,” Morningstar analyst Cara Esser said of the buy-write funds. Dozens of them are out there, some as ETFs and others as closed-end funds.
An ETF may be preferable to investors because they are transparent; the investment policies of closed-end funds are as varied as the personalities of their managers. But the bottom line to remember is that any buy-write strategy is conservative by nature.
It is designed to cut losses when the market is down, but it also trims gains when stocks rally. Those eager to try options will like the convenience, but convenience always has a price.
‘BETTER’ IDEAS: William Blair & Co. is out with its latest list of “better value” stocks, those it thinks will outperform the major indexes over the next two years. These lists are always worth highlighting because of Blair’s record: It has issued the lists roughly every two months since 1976, and the average return for each one is 33.6 percent, vs. 18.1 percent for the S&P 500.
Drum roll, please. The stocks on the new list are: American Express (AXP) and Tyco International (TYC) for large caps, F5 Networks (FFIV), Cintas (CTAS), IDEXX Laboratories (IDXX), Tempur-Pedic International (TPX), FTI Consulting (FCN) and Pandora Media (P) for mid caps, and RBC Bearings (ROLL) and Dynavax Technologies (DVAX) for small caps.
AXP is seen as a primary beneficiary of the global trend to electronic payments. The industrial conglomerate TYC will be broken up in the second half of 2012, and Blair believes the parts will collectively be worth about $65 a share. TYC closed Friday at $48.55.
Of the smaller companies, note the inclusion of Internet radio provider Pandora, which Blair said has a 65 percent market share in the United States and is securing agreements with automakers to add its service.
NOT SO DOUR: Contrarians, beware. The outlook for an improved economy has gotten institutionalized. The Northern Trust (NTRS) survey of institutional investment managers found a brighter view in the fourth quarter of 2011.
Northern Trust said 81 percent of respondents expect stable or improved job growth in the next six months and that 74 percent expect stable or accelerated growth in the nation’s Gross Domestic Product. Both results are up substantially from the survey in the third quarter.
CLOSING QUOTE: “It’s not unusual when we have a period of high volatility in the marketplace that we simply tire out our investors.” — Edward Tilly, president, CBOE Holdings (CBOE), on a late-2011 dropoff in volume at the options exchange and for trading in general.
Article from Chicago Sun Times
