Have Buy-Write Funds Impacted Premiums?

[AAAintheBeltway]

Roger Nussbaum has a column on RealMoney today discussing buy write funds, which pursue a strategy of buying a diversified portfolio of common stock and selling calls against them. Since he first mentioned them, in September, they have lagged the market. His reason for owning them as part of a managed portfolio involves diversisfication, hoped for smoother returns than pure equity and a more predictable yield than bond funds. Whatever. Personally, I wouldn't want them. We concluded form the extensive discussion here previously that the strategy does not add value, as premiums discount future volatility.

He mentions the proliferation of such funds as an obvious problem. I am wondering if the pros out there have noticed any impact from these funds. I read separately that buy write is the favorite retail options strategy. I'm not suggesting these funds are behind the collapse in VIX, but certainly this much selling pressure should have an effect.

 

[ssternlight]

Not an expert, but I really have to wonder if buy/write funds have the critical mass in $'s necessary to make a noticable dent in premiums.

 

[AAAintheBeltway]

Quote from ssternlight:

Not an expert, but I really have to wonder if buy/write funds have the critical mass in $'s necessary to make a noticable dent in premiums.

That was pretty much my question. These funds are not small fry, but neither are they Magellan.

Of the five he listed:

Madison-Claymore $278 mill

S&P 500 CC Fund $310 Mill

First Trust CC Fund $373 mill

Nuveen Equity Prem Inc fund 717 mill

ING Global Equity Div. 1.7 Bill

So that's over $3 billion in assets. So if they spread the assets equally over, say 100 names, that's $30 mill a name that could potentially have calls written against it. Assume a $30 price for the stock, and you get 1 million shares or 10,000 contracts. Seems like a lot to me, but I know my assumptions way overstate the actual number. Anyway, it's hard for me to believe that any concept that is being marketed this hard to retail will be successful.

 

[ssternlight]

Quote from AAAintheBeltway:

That was pretty much my question. These funds are not small fry, but neither are they Magellan.

Of the five he listed:

Madison-Claymore $278 mill

S&P 500 CC Fund $310 Mill

First Trust CC Fund $373 mill

Nuveen Equity Prem Inc fund 717 mill

ING Global Equity Div. 1.7 Bill

So that's over $3 billion in assets. So if they spread the assets equally over, say 100 names, that's $30 mill a name that could potentially have calls written against it. Assume a $30 price for the stock, and you get 1 million shares or 10,000 contracts. Seems like a lot to me, but I know my assumptions way overstate the actual number. Anyway, it's hard for me to believe that any concept that is being marketed this hard to retail will be successful.

Well,

MSFT is running 100K contracts at ATM so it would seem like there must be some impact from writing less worthy names.

Of course, everyone runs the same models so no one is going to sell premium too cheaply. They're not in the business of losing money after all.

Best guess ( on two seconds thought) is that they are a positive force for making prices more reflective of the models but no more than that.

I'll give it some more thought/research after the close...

Anecdotally, I talked with a manager of a couple of offshore funds $150M or so. He said that the due diligence/risk management people's hair turned white when they found out he couldn't liquidate his buy/write positions simultaneously or even intraday. And that they filled out the redemption forms right there...

 

[Profitaker]

Quote from AAAintheBeltway:

I'm not suggesting these funds are behind the collapse in VIX, but certainly this much selling pressure should have an effect.

The vast majority of funds are long equity. Any hedge would involve buying protective Puts or selling covered calls or a combination of both.

Thus there is constant buying pressure on Puts and constant selling pressure on Calls which is precisely what causes the asymmetric Vol smile (skew) in Index options.

Nothing new.