Buy-Write Funds
Buy-write funds – often synonymous with covered call funds – have gained popularity among income-focused investors.
These funds combine equity investment with an options strategy to enhance income, a strategy of which we’ve written about here.
In this article, we’ll look deeper into buy-write funds, how they work, their advantages and risks, and review some of the most popular funds available today.
Key Takeaways – Buy-Write Funds
- Reliable Income Stream – Buy-write funds generate regular income through premiums from call options, with yields ranging from mid-to-high singles into the double-digits, ideal for short-term cash flow needs or as a means for better long-term compounding.
- Volatility Management – These funds reduce portfolio volatility (call option income can offset price drops). Can make them a safer option for traders during uncertain or flat markets.
- Short-Term Strategies – Traders can leverage funds like XDTE, which use daily option strategies, to maximize gains in short timeframes.
- Capped Upside – Upside is limited to the strike price of the options sold, making these funds less suitable for bullish markets.
- Expense Ratios and Yields Matter – Assess expense ratios and dividend yields carefully to balance income potential and costs effectively.
- How to Make These Funds on Your Own – You can also create these types of exposures on your own based on your goals and preferences.
What Are Buy-Write Funds?
Definition and Strategy
A buy-write fund uses a covered call strategy.
This involves purchasing a portfolio of stocks (though it can be done on other assets as well) and simultaneously selling call options on those stocks.
The premiums collected from selling options provide additional income for the fund.
How Do They Work?
- Stock/Asset Ownership – The fund buys underlying assets, typically quality stocks or indices like the S&P 500 or NASDAQ.
- Option Writing – The fund sells call options against these holdings. These options give the buyer the right to purchase the stock at a predetermined price (strike price) within a specific timeframe. They’re sold some percentage out of the money at a duration typically from one month out to a year, and repeated over time. Being close to the current level of the index adds more income but also limits upside.
- Income Generation – The premiums earned from selling options act as an income source, distributed to investors as dividends.
Why Are Buy-Write Funds Popular?
Appealing to Income Investors
The primary attraction of buy-write funds is their ability to generate consistent and high yields, often ranging from 7% to 18% (though it depends).
This is appealing in an environment where cash or fixed-income yields are lower or for those seeking reliable income.
Volatility
Covered call strategies can reduce portfolio volatility.
They do limit upside potential, but they provide a cushion during market downturns from the call option income offsetting at least some of the fall.
In a steep enough market downturn, the income generated from call option premiums may not fully offset the decline in the underlying asset’s value. But it can nonetheless still help reduce losses compared to a portfolio without this strategy.
Key Benefits of Buy-Write Funds
1. Enhanced Income
The premiums from selling options provide regular payouts, often distributed monthly.
Traditional dividend stocks typically issue dividends quarterly, but many funds nowadays do monthly due to popular demand (i.e., it can help to match better with expense outflows and may simply feel better to get paid more frequently).
2. Portfolio Diversification
These funds often include a broad range of equities (typically indexes), offering diversification across sectors and industries.
3. Downside Protection
From collecting premiums, buy-write funds reduce losses in bearish markets.
This makes them less volatile than traditional equity funds.
They also tend to have better Sharpe ratios, though there are of course nuances to consider.
4. Tax Efficiency
Certain buy-write funds are structured to maximize after-tax returns, with some premiums classified as return of capital.
Risks Associated with Buy-Write Funds
1. Limited Upside Potential
The upside of the underlying stocks is capped at the strike price of the options sold.
In strong bull markets, buy-write funds underperform compared to pure equity strategies.
2. Market Risk
While covered calls offer some protection, buy-write funds are still exposed to overall market declines.
3. Complexity
The options strategy adds a layer of complexity.
This makes it important to understand the mechanics of these funds.
Top S&P 500 Buy-Write Funds
Below, we look at several prominent buy-write funds, each with unique strategies and features.
Note that dividend yields are dynamic, and expense ratios can change over time as well, so please independently verify any details on any funds you might be interested in.
1. NEOS S&P 500 High Income ETF (SPYI)
SPYI targets a 12% annual distribution by dynamically writing out-of-the-money (OTM) calls.
Its active management allows flexibility to adjust aggressiveness based on conditions.
- Dividend Yield: 11.63%
- Expense Ratio: 0.68%
Pros:
- Dynamic strategy adapts to market trends
- High target distribution
Cons:
- Sacrifices total returns for income
2. JPMorgan Equity Premium Income ETF (JEPI)
JEPI is a conservative fund focusing on lower volatility and steady income.
It’s also a larger fund, with tens of billions in AUM.
Unlike traditional buy-write funds, it selects a unique stock portfolio and writes options on a smaller portion.
- Dividend Yield: 7.08%
- Expense Ratio: 0.35%
Pros:
- Lower volatility
Cons:
- Lower yield compared to competitors
3. Roundhill S&P 500 0DTE Covered Call Strategy ETF (XDTE)
XDTE is a bold entrant that writes daily options, allowing it to take advantage of short-term volatility.
Its high yield and weekly distributions make it a unique choice.
- Dividend Yield: 18.54%
- Expense Ratio: 0.95%
Pros:
- Highest yield among peers
- Captures more upside with daily options
Cons:
- Higher risk due to frequent option writing
4. Goldman Sachs S&P 500 Core Premium Income ETF (GPIX)
GPIX combines a conservative yield target (8.5%) with strong capital appreciation.
It focuses on writing at-the-money (ATM) options.
- Dividend Yield: 8.02%
- Expense Ratio: 0.29%
Pros:
- Strong total returns
- Balanced strategy
Cons:
- Lower yield may not appeal to high-income seekers
5. ProShares S&P 500 High Income ETF (ISPY)
ISPY uses a conservative approach, targeting a 9.13% yield while preserving potential for capital appreciation.
It uses OTM options and avoids leverage.
- Dividend Yield: 9.13%
- Expense Ratio: 0.55%
Pros:
- Balanced income and growth
- Conservative option strategy
Cons:
- May underperform in highly volatile markets
Honorable Mentions
1. Global X S&P 500 Covered Call ETF (XYLD)
With over a decade of performance data, XYLD offers consistency but lacks innovation compared to newer funds.
- Dividend Yield: Approximately 9%
2. Defiance S&P 500 Target Income ETF (SPYT)
Targeting a 20% yield, SPYT is risky but enticing for aggressive income seekers.
- Dividend Yield: 20%
Is a Buy-Write Fund Right for You?
Ideal Candidates
- Retirees – Looking for regular income with reduced volatility.
- Income Investors – Interested in high yields.
- Moderate-Risk Investors – Looking for moderate growth and income.
Who Should Avoid?
- Growth-Oriented Investors – The capped upside may limit returns in bullish markets.
- Risk-Averse Individuals – Funds like XDTE and SPYT can be volatile.
How to Evaluate Buy-Write Funds
Key Metrics to Consider
- Dividend Yield – Reflects income potential but shouldn’t be the sole factor.
- Expense Ratio – Lower costs enhance net returns.
- AUM (Assets Under Management) – Indicates fund stability and popularity.
- Historical Performance – Offers insights into risk and reward.
- Inception Date – Longer track records provide reliability. Many funds are on the newer side.
Buy-Write Funds Across the Trader-Investor Spectrum
Buy-write funds can appeal to both investors and traders, depending on their financial goals and strategies.
Investors
For investors, these funds are primarily used for generating consistent income and reducing portfolio volatility.
Investors often appreciate the stability provided by the covered call strategy, which offsets some market losses during downturns while delivering regular dividend-like payouts.
Retirees or income-focused investors find buy-write funds attractive for long-term, steady cash flow.
Traders
For traders, buy-write funds can serve as an income-generating vehicle within a broader, more dynamic strategy.
Traders may use these funds as a way to park capital when they’re less confident in markets, during a period of inactivity, or when they expect limited price movements in the underlying index or assets.
The consistent option premiums collected by the fund provide traders with regular income, which can complement gains from other, more speculative trades.
Additionally, the higher yields of certain buy-write funds, such as those using aggressive strategies like daily option writing, align well with traders’ short-term income goals.
It’s also something they can pursue in the context of their own trading, if desired.
How to Create These Funds on Your Own
Traders can actively recreate the strategy behind buy-write funds by implementing a covered call approach on their own.
This involves buying shares of an underlying asset, such as a stock or ETF, and simultaneously selling call options on those shares.
This requires more effort and active management compared to investing in a buy-write fund, but it provides traders with greater control over the strategy and potential costs.
Example: Recreating a Buy-Write Strategy
Suppose you want to replicate a strategy similar to the NEOS S&P 500 High Income ETF (SPYI), which dynamically sells out-of-the-money (OTM) call options.
1) Stock Purchase
Begin by purchasing shares of SPY to serve as your underlying asset.
For instance, if SPY is trading at $600, you could buy 100 shares, costing $60,000.
2) Call Option Writing
Sell one OTM call option per 100 shares of SPY.
If SPY is at $600, you might sell a call option with a strike price of $605 expiring in one month.
Suppose the premium for this option is $5 per share, you would collect $500 in premium income.
3) Income Generation
If SPY remains below $605 by expiration, you retain the $500 premium, generating a 0.83% return on your initial investment in one month (which would come out to around 10.5% annualized via compounding).
If SPY rises above $605, your upside is capped, but you still benefit from the stock’s appreciation up to $605 and the premium collected.
4) Repeat
As the option expires, you can write another call, adjusting the strike price and expiration based on your goals.
Conclusion
Buy-write funds offer a blend of income generation and portfolio stability.
Nevertheless, they’re not a one-size-fits-all solution.
It’s important to first understand the nuances of these funds and evaluate your financial goals, you can determine whether they belong in your portfolio.
From conservative choices like JEPI to high-yield options like XDTE, there’s a buy-write fund for various tastes and preferences.
Traders can also tailor this strategy to align with their income goals and market outlook by actively managing strike prices, expirations, and the timing of trades – essentially recreating the mechanics of a buy-write fund if they so choose.