Two "Options" for High Yield

04/07/2006 12:00 am EST

Focus:

Carla Pasternak

Editor, The Income Investor

Carla Pasternak, editor of High-Yield Investing, has uncovered a pair of new closed-end funds from Eaton Vance and BlackRock that use various options-based strategies to provide 9%+ yields. For more sophisticated income investors, we share her ideas.

"What's not to like about a fund that pays a sizzling 9.6% dividend, invests in the world's largest companies, and trades at a bargain price? Eaton Vance Tax-Managed Global Buy-Write Opportunities Fund (ETW NYSE), a closed-end fund, gives investors a chance to profit from leading blue-chip stocks in such markets as the US, Europe, the UK, and Japan.

"Although ETW offers one of the highest dividend yields on the market today, the fund is more conservative than many of its brethren. Its rock solid portfolio is diversified among nearly 600 blue-chip stocks listed on the benchmark indices of the world's most powerful economies. Not only that, the fund has virtually no debt. As a result, it is far less sensitive to changes in interest rates and its returns should be more stable than most closed-end funds.

"And, the shares are selling for less than the value of the fund's portfolio holdings. The fund's portfolio carries a net asset value of $19.52 per share, yet you can buy the fund today for $18.67 per share. As such, now is an excellent time for investors to take a closer look at shares of the Eaton Vance Tax-Managed Global Buy-Write Opportunities Fund.

"This fund is a newcomer, launched last September by veteran money manager Eaton Vance. Its name is a long one, but it points to a key moneymaking strategy that its managers employ. The fund buys the member stocks listed on the benchmark indices of the US, Europe, UK, and Japan. The fund's managers then write ‘call options’ on these stock indices, betting that an index will close below the price set on the options. If that happens, then the option expires worthless and the fund generates extra income from the option premiums.

"This strategy is certainly not risk-free. The risk is that if the market falls sharply, the fund could lose more due to a decline in stock value than it makes from its option premiums. Also, if the market rises quickly, then the fund could make less than if it had simply held its stocks without writing options on them. In other words, the strategy works best in a relatively flat market. However, downside is limited by the fact that the fund invests in solid companies, from nearly 600 different issuers.

"ETW is too new to have chalked up a track record, but so far this year it has outperformed the benchmark S&P 500 with a 7% share price gain. ETW paid its first quarterly dividend of 45 cents per share last December. That equates to an annual payment of $1.80, which gives the fund a generous 9.6% yield at today's prices. Closed-end fund dividends are generally taxed as ordinary income, but ETW provides tax-advantaged dividends to shareholders, which qualify for a reduced 15% tax rate or for deferred tax treatment. That makes the fund ideal for taxable accounts and keeps the after-tax dividend yield attractive.

"Overall, this fund is a play on the world economy. If you think that markets in the world's major economies will remain largely range-bound, without rising or falling steeply, in the months or years ahead, then this fund should deliver solid returns for its shareholders. Most high-yield equities are equally high-risk, but I believe ETW is more conservative than most and would make an attractive investment for a medium-risk portfolio."

"With nearly $320 million to put to work, BlackRock Global Opportunities Equity Trust (BOE NYSE) invests in a diverse portfolio of over a hundred stocks from about two-dozen different countries. The portfolio is fairly conservative, with nearly half of its investments in such stable, developed countries as the UK, Japan, and the US. The fund collects dividend income from the stocks in its portfolio. Unlike many other closed-end funds, BOE doesn't borrow money to buy more assets. Instead, it writes options on the stocks in its portfolio and makes money by collecting premiums when it sells these options.

"The strategy is not without risk. When the fund writes options, its management team is betting that the share price of a given stock will go no higher (call option) or lower (put option) than the price at which the option was issued (strike price). If the share price moves above or below the range set by the option, then the fund could lose money when it is forced to buy the options back, or when the options expire. The risk is that the fund could lose more money when repurchasing its options than it brings in initially from the option premiums it receives. Still, as long as management employs this options strategy carefully, the downside risk is limited.

"BOE pays a quarterly dividend of 57 cents per share, or $2.28 annually, giving the fund a 9.1% yield. Although it uses income earned from selling options to help boost returns, the dividend income from the fund's investments provides a stable income stream. Like most closed-end funds, BOE's dividends are taxed as ordinary income. As such, investors may want to consider holding the fund in a tax-deferred account such as an IRA.

"The shares are trading at a 3.5% discount to the value of the fund's underlying investments. The fund is too new to have a performance history, but so far this year BOE has returned a market-beating 13.2%. The fund's strategy of writing options on stocks it owns works well when equity prices remain flat. The strategy has worked well to date, but its success in more volatile markets is yet untested. As such, BOE is best suited for medium-risk investors who fully understand the risks and rewards associated with trading options."

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