As covered call writers we strive to generate monthly cash flow by selling call options in a conservative, low-risk environment. This approach is quite appealing to many retail investors but many look to fund managers to take advantage of this great strategy. As a result there are now 31 closed-end funds that use covered call writing in a majority of their portfolios. Closed-end funds (CEFs) raise a prescribed amount of capital ONE TIME via an IPO by issuing a fixed number of shares which are purchased by investors as stock. Mutual funds which have no restrictions on the number of shares issued are called open-end funds. A covered-call CEF buys stocks and sells call options on some of those shares with the goal in mind of boosting income.
Most covered call writers write calls which are at-the-money or slightly out-of-the money. The same holds true for covered-call funds. Typically, the strikes are 1-3% above current market value of the securities. As stated in my books and DVDs, this approach works well in most market conditions: moderately bullish, moderately bearish and neutral markets.
About half the covered-call funds write options on individual equities while the other half write on indexes that reflect their underlying holdings. Since premiums on individual equities are higher than those on indexes some funds will overwrite a smaller portion of their portfolios stocks leaving the larger portion open to greater share appreciation. Funds that sell index call options receive a lower premium return but allow shares to appreciate as much as possible. The fund may have to deliver the underlying index, if exercised, as shares are sold in these cases.
Analysis of covered-call funds:
There is a huge variation in the strategies of covered-call CEFs:
- Domestic, foreign, or sector-specific
- Dividend-focused or value-focused
- Strike selection varies
- Some use put options for protection
- Expense ratios (administrative fees-these funds average about 1%)
Here is a list of the 31 covered-call CEFs that overwrite at least 50% of their portfolios showing the type of option used, strike preferences and percentage of portfolio overwrite (as per Morningstar):
ETV: + 11%
GPM: + 10%
JPZ: + 8.5%
JLA: + 8%
ETB: + 7.5%
JPG: + 7%
Alan and Linda at the ING Direct Cafe for last week’s seminar (notice the blue collar!):
This week’s economic reports reflected a recovery still on shaky ground:
Business inventory rose 0.4% in April due to increases in retail inventory levels
The inventory-to-sales ratio (measure of how many times a company’s inventory is sold and replaced in a given time frame) is maintaining a healthy level @ 1.26
The Producer Price Index (PPI) fell by 1.0% in May, more than the drop of 0.6% expected
Excluding food and energy, the PPI rose 0.2% in May matching April’s increase
Retail sales fell 0.2% in May, the 2nd consecutive monthly decline
The Consumer Price Index, a measure of inflation, fell 0.3% in May mainly due to the steep decline in the energy index as gas prices fell. Inflation concerns seem to be calmed in the near term
Industrial production declined by 0.1% in May as a rise of 0.1% was anticipated
Initial jobless claims for the week ending 6-9-12 came in at 386,000 higher than the 375,000 expected
For the week, the S&P 500 rose by 1.3% for a year-to-date return of 7.9%, including dividends.
A 6-month chart of the S&P 500 shows the index moving above its 200-d simple moving average in early June and approaching its 50-d SMA:
- VIX as of 6-15-12