Schaeffer's Trading Floor Blog

The Secret to Success with Options-Based Funds

Long-term investors may have the best results with buy-write funds

by 2/25/2015 9:25 AM
Stocks quoted in this article:

The paper we cited yesterday claimed that option-based exchange-traded funds (ETFs) outperformed the S&P 500 Index (SPX) over the long haul, and did so with reduced portfolio volatility. And I don't dispute that conclusion. But it's important to remember that results may vary.

In other words, over shorter time frames, you may end up quite disappointed. I intuitively thought that the last couple of years were likely good times for "buy-write"-type funds. We've rallied, but not explosively so. And implied volatility has consistently overpriced realized volatility. It seems like a good backdrop.

But maybe not. Here's a look at Horizons S&P 500 Covered Call ETF (HSPX) versus SPX over the past 1.75 years.

HSPX vs. SPX over the past 1.75 years

I have to admit, I've never heard of HSPX. Here's the description:

"HSPX invests its total assets in all the securities of the S&P 500 ® in substantially similar weights, and sells or "writes" covered call options on up to 100% of each of the option-eligible securities in the portfolio in an attempt to generate additional monthly income from the call option premiums collected."

So in other words, it buy-writes every name it can in SPX -- sounds perfect for this study. Yet, look at the graph; it barely captured one-third of the SPX gains.

Maybe selling calls on individual names doesn't work so well on a net basis. Even though index options tend to overprice ultimate realized volatility, the same isn't true for all stocks. There are all sorts of big moves on earnings, mergers, or whatever. And the losers could dwarf the winners in size. So how about we look at a fund that just sells index calls -- like the PowerShares S&P 500 BuyWrite Portfolio (PBP).

"The PowerShares S&P 500 BuyWrite Portfolio (Fund) is based on the CBOE S&P 500 BuyWrite Index ™ (Index). The Fund generally will invest at least 90% of its total assets in securities that comprise the Index and will write (sell) call options thereon. The Index is a total return benchmark index that is designed to track the performance of a hypothetical "buy-write" strategy on the S&P 500 ® Index. The Index measures the total rate of return of an S&P 500 covered call strategy. This strategy consists of holding a long position indexed to the S&P 500 Index and selling a succession of covered call options, each with an exercise price at or above the prevailing price level of the S&P 500 Index. Dividends paid on the component stocks underlying the S&P 500 and the dollar value of option premiums received from written options are reinvested. The Fund and the Index are rebalanced and reconstituted quarterly."

Sounds good. But here's the chart of PBP versus SPX over the same time frame as above.

PBP vs. SPX over the past 1.75 years

Oops. That 2.8% return stands up pretty poorly versus the 36% SPX gain.

How about Barclays ETN+ S&P VEQTOR ETN (VQT)? I've mentioned this pup before. It's a little different in that it's dynamic. It sits with a pure SPX position until volatility makes a predetermined move, at which point it purchases CBOE Volatility Index (VIX) hedges. And if volatility keeps going, it goes to all cash. It wouldn't qualify for the study in that it's not an options-based ETF per se (yes, I know VIX itself is options-based), but it should accomplish the same smoothing of market moves. Anyway, here it is stacked up against the SPX.

VQT vs. SPX over the past 1.75 years

Well, it is better than the others -- VQT picked up about half the gains of SPX. And it should do very well (on a relative basis) in a weak market, as it would get to all cash at some juncture.

Now, it's not terribly fair to pick out one two-year slice of two ETFs in a study that looks at 80 funds and goes back to 1988. But it is key to note that lots of investors have bought into these types of funds or tried to replicate the ideas on their own, and they've come away disappointed for no other reason than they had unfortunate timing. It's a solid portfolio idea; it just requires a very long-term time horizon to see the full benefits they lay out.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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Analyst Downgrades: Hewlett-Packard Company, Marvell Technology Group Ltd., and Boston Beer Company, Inc.

Analysts downwardly revised their ratings on Hewlett-Packard Company (HPQ), Marvell Technology Group Ltd. (MRVL), and Boston Beer Co Inc (SAM)

by 2/25/2015 9:10 AM
Stocks quoted in this article:

Analysts are weighing in today on computer concern Hewlett-Packard Company (NYSE:HPQ), chipmaker Marvell Technology Group Ltd. (NASDAQ:MRVL), and craft brewer Boston Beer Co Inc (NYSE:SAM). Here's a quick roundup of today's bearish brokerage notes on HPQ, MRVL, and SAM.

  • HPQ is down 6.5% in electronic trading, after the firm's worse-than-expected fiscal first-quarter revenue and downwardly revised current-quarter and full-year earnings outlook triggered a wave of price-target cuts. RBC Capital, for example, reduced its price target by $1 to $38, saying, "HP disappointed on multiple fronts this quarter, leaving us concerned about the future revenue and margin trajectory." Also weighing in was Cantor, which lowered its price target by $4 to $35, representing a discount to last night's close at $38.49. Today's projected price move will more than likely be a disappointment to options traders, who were upping the bullish ante ahead of earnings, and could have Hewlett-Packard Company testing support at its 40-week moving average -- a trendline that has lifted the stock higher for the past two years.

  • After boosting its price target on MRVL to $17 on Friday, Stifel cut its outlook on the stock to "hold" from "buy" overnight. Technically speaking, the equity has done well in 2015, boasting an 11.6% gain. What's more, the security hit a two-year post-earnings high of $16.78 last week, but was more recently seen lingering at $16.18. Meanwhile, on the sentiment front, options bears have been increasing their presence of late. At the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), Marvell Technology Group Ltd.'s 10-day put/call volume ratio has jumped to 0.42 from 0.02 over the past two weeks, with the current ratio ranking in the 79th annual percentile. Simply stated, puts have been bought to open over calls at a faster-than-usual clip.

  • SAM is bracing for a 13% drop out of the gate, following a fourth-quarter earnings miss and a lower-than-forecast full-year profit outlook. In response, Jefferies slashed its price target to $338 from $372. Additionally, Cowen and Company lowered its rating to "market perform" from "outperform," and cut its target price by $27 to $308. Heading into today's session, the security had been performing well on the charts, tacking on 48% since hitting its most recent low of $210.03 in early October to trade near $310.71. As such, today's anticipated bear gap should please one group of traders -- short sellers. Short interest surged 12% over the last two reporting periods, and now accounts for a healthy 11.2% of Boston Beer Co Inc's float.

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Earnings Preview: Chesapeake Energy Corporation, Lowe's Companies, Inc., and SodaStream International Ltd.

Analyzing recent option activity on Chesapeake Energy Corporation (CHK), Lowe's Companies, Inc. (LOW), and Sodastream International Ltd (SODA)

by 2/24/2015 1:11 PM
Stocks quoted in this article:

Among the stocks gearing up to report fourth-quarter earnings tomorrow morning are oil-and-gas producer Chesapeake Energy Corporation (NYSE:CHK), retailer Lowe's Companies, Inc. (NYSE:LOW), and at-home carbonation specialist Sodastream International Ltd (NASDAQ:SODA). Below, we'll break down how options traders are positioning themselves, and how much speculators are willing to pay for their bets on CHK, LOW, and SODA.

  • CHK has been a technical laggard, with the shares down roughly 22.1% year-over-year to reach $19.85. Accordingly, puts continue to be popular in the stock's options pits, as Chesapeake Energy Corporation's 50-day International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) put/call volume ratio of 1.46 sits in the 85th percentile of its annual range. However, traders anticipating a negative post-earnings reaction have reason to be wary -- in the session following its last four earnings reports, CHK has advanced an average of 1.7%, including a 6.9% gain this past November. Short-term speculators are paying below-average prices for their bets on the stock, as its Schaeffer's Volatility Index (SVI) of 41% sits in the 30th percentile of all similar readings taken over the past year.

  • On the other hand, LOW has been a technical juggernaut, with the shares notching a fresh all-time high of $75.82 earlier today -- thanks to a halo lift from Home Depot Inc (NYSE:HD) -- but was last seen 0.9% higher at $74.39, bringing its year-over-year gain to 54.6%. Not surprisingly, calls are more popular than usual in the options pits, with Lowe's Companies, Inc.'s 10-day ISE/CBOE/PHLX call/put volume ratio of 1.87 sitting in the 76th percentile of its annual range. Meanwhile, in the session following its last eight earnings releases, the shares of LOW have gained an average of 1.5%. Premium on the equity's near-term options is currently inflated, as its SVI of 27% sits in the 73rd percentile of its annual range.

  • The shares of SODA are rebounding today, up nearly 4% to reach $18.47, after hitting an all-time low of $17.70 just yesterday. Year-over-year, Sodastream International Ltd is down about 52.8%. In the stock's options pits, put activity has rarely been this predominate among short-term traders, as SODA's Schaeffer's put/call open interest ratio (SOIR) of 2.56 sits in the 98th percentile of its annual range. Meanwhile, in the session following its last eight earnings reports, SODA has moved an average of 5.6%. Traders are paying above-average prices for their near-term bets on the stock, as its SVI of 76% rests higher than three-fourths of all similar readings taken over the past year.

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Analyst Update: FireEye, Inc., Macy's, Inc., and Shake Shack Inc.

Analysts adjusted their ratings on FireEye Inc (FEYE), Macy's, Inc. (M), and Shake Shack Inc (SHAK)

by 2/24/2015 11:48 AM
Stocks quoted in this article:

Analysts are weighing in today on cybersecurity firm FireEye Inc (NASDAQ:FEYE), retailer Macy's, Inc. (NYSE:M), and restaurant chain Shake Shack Inc (NYSE:SHAK). Here's a quick look at today's brokerage notes on FEYE, M, and SHAK.

  • This morning, FBR raised its price target on FEYE to $53 from $45 while reiterating an "outperform" recommendation, prompting the shares to advance about 0.2% to reach $43.45. Looking back, FireEye Inc is in rally mode, with the stock gaining 75% since hitting an annual low of $24.81 on Oct. 13. However, put activity in the options pits is nearing a peak, as FEYE's Schaeffer's put/call open interest ratio (SOIR) of 0.96 sits just 2 percentage points away from an annual high. Simply stated, short-term traders have rarely been more put-skewed over the past year.

  • M predicted weaker-than-expected full-year earnings and revenue earlier today, sending the shares down about 3.6% to reach $61.88. In response, Deutsche Bank cut its price target on the equity by $1 to $71 while underscoring a "buy" rating. Prior to today's drop, Macy's Inc. had been performing well, with the shares up about 10% year-over-year. Accordingly, sentiment in the stock's options pits was optimistic ahead of the retailer's quarterly results -- M's 10-day International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) call/put volume ratio of 3.04 rests in the 88th percentile of its annual range.

  • No fewer than seven brokerage firms initiated coverage on Wall Street freshman SHAK this morning, sending the shares up about 4.1% to hit $43.31. Most firms handed out the equivalent of a "hold" rating, with price targets south of the stock's current price, but Stifel initiated coverage with a "buy" recommendation and $50 price target. In a note to clients, Goldman Sachs cited "millennial relevancy [and] growing awareness outside of existing markets" as positive drivers for SHAK, but attributed its tepid "neutral" rating and $36 price target to valuation concerns. On the charts, Shake Shack Inc has struggled to muscle north of its Jan. 30 opening price of $47, which has emerged as resistance.

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Buzz Stocks: CymaBay Therapeutics Inc., The Home Depot, Inc., and SunPower Corp

Today's stocks to watch include CymaBay Therapeutics Inc (CBAY), Home Depot Inc (HD), and SunPower Corporation (SPWR)

by 2/24/2015 9:28 AM
Stocks quoted in this article:

U.S. benchmarks are hovering around breakeven before the opening bell, with investors looking forward to Fed Chair Janet Yellen's two-day testimony before Congress. Among the equities in focus are drugmaker CymaBay Therapeutics Inc (NASDAQ:CBAY), home improvement retailer Home Depot Inc (NYSE:HD), and alternative energy concern SunPower Corporation (NASDAQ:SPWR).

  • CBAY is set to jump 6.2% out of the gate, after the company announced positive mid-stage results for its gout treatment drug, arhalofenate. The shares have already been on a roll in 2015, adding nearly 25% year-to-date, settling at $12.25 yesterday. What's more, in the past three months, CymaBay Therapeutics Inc has outperformed the S&P 500 Index (SPX) by more than 66 percentage points. Analysts are all in on the shares, with the three brokerage firms tracking the stock calling it a "strong buy." Plus, CBAY's average 12-month price target comes in at $15.33 -- territory never before explored.

  • Thanks to better-than-expected same-store sales, an $18 billion share buyback program, and a price-target increase to $126 from $113 from Morgan Stanley, HD is 4.7% higher in electronic trading. The Dow component has been an outperformer on the charts, picking up 44% in the past 52 weeks to finish yesterday at $112.28. Ahead of this morning's earnings report, speculators had been placing bullish bets at the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX). Home Depot Inc's 10-day call/put volume ratio across those exchanges comes in at 1.69, higher than 71% of all similar readings in the past year.

  • SPWR is surging in pre-market action, adding on 15.7%, after the company reported it is in advanced talks to form a joint venture with First Solar, Inc. (NASDAQ:FSLR). Separately, the firm also unveiled better-than-expected fourth-quarter earnings. This projected price move is likely not sitting well with some traders. Roughly one-fifth of SunPower Corporation's float is sold short, representing nearly a week's worth of pent-up buying demand, at its average daily volume. Speculators, too, have been placing bearish bets. In the past 10 weeks at the ISE, CBOE, and PHLX, the equity has amassed a put/call volume ratio of 0.78 -- in its 92nd annual percentile. SPWR closed last night at $27.80.

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