With cash deposit rates at historical lows and the prospect of continued volatility in the share market, many investors are looking for smarter ways to enhance their income whilst reducing their exposure to share market risk.
One way of seeking enhanced income is through what’s known as a “buy/write” strategy, which uses “call options”.
A call option over shares gives the buyer of that option the right, but not the obligation, to buy those shares at a pre-agreed strike price. This can usually be somewhat above the current market price. In doing so, call option buyers are expecting the share price will rise above the strike price within the term of the option, thereby allowing them to profit by buying shares at below-market prices. They also have the alternative choice of selling their call options back to the market at a higher price. The seller of the call option receives an upfront cash payment, called the option “premium”.
By selling call options, therefore, shareholders effectively sell some of the upside capital growth potential of their share portfolio in return for an upfront cash payment. In addition to the share dividends and any franking credits, option premiums earned in this way enhance the income flows available from that share portfolio.
In a share market which is trending sideways or falling, the buy/write strategy has potential to add value, as relatively little, if any, share portfolio capital gain is given up in exchange for the option premiums earned. Returns could be further enhanced by the tendency of option premiums to increase during periods of market turbulence.
During periods when the market rises more strongly, the buy/write strategy may detract from performance as relatively more capital gain is foregone. Even in these periods of strength, the buy/write strategy may still help to dampen return volatility relative to a share portfolio without the buy/write strategy, through the option premiums received.
All up, as part of an overall diversified portfolio, selling call options over shares for additional income provides the potential to add value when compared to simply owning the shares outright, in many market conditions.
However, the problem for even sophisticated investors looking to implement a buy/write strategy themselves is that it can be time consuming, costly and difficult to implement. With this in mind, BetaShares has two share funds available that use a buy/write strategy:
Like all BetaShares funds, YMAX and UMAX are available to trade on the ASX, much like shares.
Due to the continued innovation in the exchange traded product market, products using ‘buy-write’ strategies are now available for investors on the ASX. For more information on ‘buy write’ strategies and to learn how to implement such a strategy using a exchange-traded product see here and here.