Enhancing Dividend Income through Buy-Write Strategies
Does an index or a discretionary approach make sense?
Actively managed ETFs have been around since 2008, but remain a small part of the market. That might change if investors determine that some strategies are better suited to active management than index tracking.
With short term USD interest rates above 5% -and well above dividend yields on most stocks - some investors are looking at other ways to boost income from equities.
Some single stock buy write ETFs are publishing huge yield figures of 30-40% but this could be based on “naked”, or not fully covered, selling of equity options, which could be very risky since it might expose investors to unlimited liability on the upside when selling calls. It could also be based on leveraged selling of options where the notional exposure from selling the options could add up to more than 100% of the NAV.
But unleveraged, covered call writing is a well known technique that can enhance income from equities.
This strategy is however more complicated than it sounds because selling calls can also result in missing out on some upside, if the stock rises far enough for the buyer of the option to want to exercise it and lay claim to your stock. There are also choices to be made about which strike prices to choose, and how often to rebalance the call option strikes as the share price moves, and how attractive the income is as the pricing of options goes up and down. For instance, the strikes are too close to the current price the stock gets called away, while if they are too far away they may not generate much income.
Some indices of covered call writing have performed very poorly. For instance, the CBOE S&P 500 Buy Write Index has made just 37.64% between December 14th 2016 and April 30th 2023, while the S&P 500 total return index made 105.84% over the same period.
The Amplify CWP Enhanced Income ETF (ticker: DIVO) has made 103.45%, very nearly keeping pace with the S&P 500 while offering somewhat lower volatility on both the upside and the downside. The income received from selling calls can cushion equity market declines to a small degree.
Its current distribution yield of 4.82% is triple the estimated 1.57% yield from the SPY ETF.
DIVO owns between 20 and 30 large cap US stocks, selected partly for dividend growth and also to provide a balanced industry mix, which also moves around with the economic cycle. The strategy is also somewhat tactical in determining its call writing strategy – it does not necessarily always sell calls on every stock all of the time. The managers look for stocks to outperform, or for call options to become more expensive, before deciding to sell them.
The ETF is advised by Capital Wealth Planning, and is run on a discretionary basis: human judgment rather than a computer model makes the decisions.
An expense ratio of 0.55% is slightly below average for a range of buy-write ETFs monitored by VettaFi. The Invesco S&P 500 Buy Write ETF, which tracks the aforementioned CBOE index, charges 0.49%. Meanwhile, many other products charge 0.80% or 0.85%.
Given the apparent added value of the active management in this strategy, small differences in the expense ratio could be far less important than when comparing index trackers.
