Investors often look for ways to enhance income, lower a portfolio’s overall expected volatility or even help manage taxable gains.
This post covers all three goals.
Specifically, how a type of option strategy employed in the WisdomTree CBOE S&P 500 PutWrite Strategy Fund (PUTW) has the potential to enhance portfolios during volatile markets.
PUTW’s Strategy: CBOE S&P 500 PutWrite Index
PUTW seeks to track the price and yield performance, before fees and expenses, of the CBOE S&P 500 PutWrite Index (PUT Index). The PUT Index includes a strategy of writing at-the-money puts on a monthly basis.
You can think of a put option as an insurance contract. The writer plays the part of the insurer, who charges the owner a premium to ensure the price of their underlying asset if it falls below the strike price agreed upon in the contract.
The options sold by the PUT Index use the S&P 500 Index (S&P 500) as the underlying asset.
At-the-money means the strike price agreed to on these contracts is equal to the current price of the S&P 500.
For example, on March 18, 2022, the PUT Index strategy wrote a contract with an April 14, 2022, expiration date and 4,410 strike price. The S&P 500 Index traded around those levels at the time of this transaction.
Options written by the PUT Index settle on the expiration day. There are two potential outcomes, dependent on the price of the S&P 500:
- If the price of the S&P 500 at settlement is at or above the strike price, the PUT Index will keep the full premium it initially collected.
- If the price of the S&P 500 is below the strike price, the PUT Index is required to pay the difference between the strike price and the current level of the S&P 500. This difference can be more or less than the premium initially collected.
Given this payoff structure, the month-to-month upside of the PUT Index is capped by the percent premium it collects (premium collected/strike price), while the downside depends on the movement of the S&P 500, which can be mitigated by the premium initially collected. The PUT Index has a shock absorber equal to the percent premium it collected.