By Tom Lydon:
ALPS Portfolio Solutions has launched a new exchange traded fund that provides investors with income through selling put options on the largest U.S. stocks with the highest volatility.
The U.S. Equity High Volatility Put Write Index Fund (HVPW - News) tries to reflect the performance of the NYSE Arca U.S. Equity High Volatility Put Write Index, which tracks a portfolio of exchange-traded put options on the largest capitalized stocks that have listed options with the highest volatility, according to ALPS. HVPW has a 0.95% expense ratio.
Put options are a type of financial instrument used to provide the owner the right, but not the obligation, to sell the security at a set price, or "strike" price, on or before an expiration date.
Traders who write put options have essentially sold the right to another investor to sell shares at an agreed-upon price. On the other hand, the buyer has the purchased the chance to sell stock to the put writer.
In other words, the party who writes puts acts as an insurance provider for the portfolio's downside, but gains access to premiums, or income. High-volatility stocks have bigger premiums because they are viewed as riskier.
"Selling a put is advantageous to an investor because he or she will receive the premium in exchange for committing to buy shares at the strike price," Investopedia explains. "If the price of the stock falls below the strike price, the put seller will have to purchase shares from the put buyer when the option is exercised. Therefore, a put seller usually has a neutral/positive outlook on the stock or expects a decrease in volatility that he or she can use to create a profitable position."
The ETF will sell 60 day listed put options every two months on 20 stocks. HVPW will also distribute 1.5% of the ETF's net assets at the end of each 60 days.
Rich Investment Solutions, LLC is the subadvisor to the ETF, which was launched under the ALPS ETF platform.
In a telephone interview, Kevin Rich of Rich Investment Solutions said the ETF sells puts that are 15% "out of the money." The fund tries to earn income through the options premiums.
The ETF should do well when markets are trending higher or sideways, but could underperform in strong rallies and sell-offs.
"It's definitely an income strategy," Rich explained. He also said many investors are stretching for yield and taking on risk in a low-interest-rate environment.
"This is a nice alternative strategy," said Rich, adding that the ETF is fully transparent and provides daily liquidity.
"No other ETFs do this, and the closed-end and mutual funds that do are more expensive," he said. "We didn't invent put writing. We're just wrapping the strategy into an effective ETF vehicle."
According to a fact sheet on the fund, investors assume the risk that the selected stocks may close below their strike price. They also "give up the upside on the underlying equities above the income the fund receives from selling the options."
There are existing exchange products that use a different options strategy known as put-write. These include PowerShares S&P 500 BuyWrite (PBP - News), AdvisorShares STAR Global Buy-Write (VEGA - News) and iPath CBOE S&P 500 BuyWrite ETN (BWV - News). The buy-write, or covered call, strategy utilizes call options on a position to generate high income from option premiums.
Max Chen contributed to this article.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.