New ETN Pays You to Own Gold

Roger Nusbaum

NEW YORK (TheStreet) -- Credit Suisse this week launched an interesting exchange traded note with the Gold Shares Covered-Call ETN GLDI . The big idea is that the fund will track an index that synthesizes owning the SPDR Gold Trust GLD overlaid with a covered-call strategy, then payout the premium by selling the calls in a monthly distribution. Strategically this is not complicated, but where this is an exchange-traded note, there are specific details of how the fund achieves this that must be understood by anyone interested in buying the fund.

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The first point is that the ETN will not actually buy shares of GLD, or sell any covered calls. It will instead maintain "notional" positions and execute "notional" trades. This is normal under the hood of an ETN, but it is important to realize that this is the case here.
The "notional" option strategy is plainly spelled out in the fund's literature. Forty days before the expiration, the strategy will select call options to sell that are 3% out of the money and then notionally sell those calls over the next five days. Then 5-9 days before expiration, the strategy will buy the calls back, while looking to sell the next round of call options. The distribution will be paid seven days after the options expire and will be comprised of the option premium received less any notional trading costs. One cost embedded in all of this will be the 0.65% expense ratio.
Repurchasing the calls before expiration will be done by selling a small amount of GLD to pay for the repurchase. The positive is that this cost will not subtract from the payout, but the negative is that this will have a dilutive effect on the ETN. Credit Suisse believes the dilution will be negligible, but that might not be the case, it depends on how GLD and its options trade in the future. The fund was structured this way to protect the distribution.

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Another important building block of understanding is that in selling call options that are 3% out of the money, the price of GLDI will not go up more than 3% in a month. If in a given month GLD goes up 6%, GLDI would be expected to only go up 3%. In the trailing 12 months, there were three different months where GLD went up more than 3%. Selling covered calls will offer some downside protection in case GLD drops, but only to the extent of the premium taken in.
The index that the note tracks was created in November and although it has been untradeable, Credit Suisse says that if it had been available, the monthly distributions would have annualized to a 9.45% distribution percentage. It is very important to understand that any actual payments made to note holders could vary.
The timing of this launch may turn out to be poor given the recent news of investors possibly getting hurt by equity-linked structured products, a different type of note tied to Apple AAPL , that could force note holders to buy AAPL stock near $700, even though it is now trading well below $500. While the structure of GLDI is nothing like the AAPL notes, investors may be wary of products linked to stocks or ETFs offering potentially high yields. The notes linked to AAPL were issued with an 8% yield. This episode has raised questions about whether the AAPL notes were issued to investors as an inexpensive hedge for a position in AAPL stock.

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Credit Suisse will hedge its exposure to GLDI by trading GLD through its "affiliates." While I am satisfied that the bank's primary objective of GLDI is to get paid for offering an investment product to the public, as opposed to trying to hedge a proprietary position in GLD, this is something that individuals need to weigh for themselves.
One last point is that by utilizing a strategy that caps monthly gains at 3%, the disaster insurance element of owning GLD is at the very least muted if not eliminated altogether. However, GLDI should capture a large portion of a slow steady rise in the price of gold that might occur if inflation rates increase meaningfully over an extended period.

At the time of publication, the author and a client held positions in GLD, although positions can change at any time.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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