Protecting Profits in a Nowhere Market

02/10/2010 12:00 pm EST

Focus: ETFS

Jim Lowell

Senior Partner & Chief Investment Strategist, Adviser Investments

Jim Lowell, editor of Forbes ETF Advisor, says a “buy-write” or “covered call” fund can protect investors from sudden big market moves.

January is a month that is viewed as follows: As it goes, so the year will go.

Well, last year the market sold off 11% in January. Apparently, the rest of the year missed that memo. This January ended in the red; I’ll still wager we end the year in the green.

Getting from here to there will likely be more trying. The market volume has been anything but affirmative of a trend so far. Tentative buyers are few, traders continue to serve as the daily trigger. The year-long trend is likely higher highs across stock and commodity boards iff (that’s the symbol in logic for “if and only if”) slow recovery here and robust recovery in China and India don’t turn into no recovery here and slower recovery there.

The PowerShares S&P 500 BuyWrite ETF (NYSEArca: PBP) seeks investment results that correspond to the price and yield performance of the CBOE S&P 500 BuyWrite Index. It invests at least 80% of total assets in stocks included in the Standard & Poor’s 500 index and will write (sell) call options thereon. The index measures the total rate of return of an S&P 500 “covered call” strategy.

PBP began trading in December 2007 and has a market value of $158 million. The top three sectors are information technology (19.5%), financials (14.6%), and health care (13.1%). The top ten holdings [include] Exxon Mobil (NYSE: XOM), Microsoft (Nasdaq: MSFT), Apple (Nasdaq: AAPL), Proctor & Gamble (NYSE: PG), and Johnson & Johnson (NYSE:JNJ).

A covered call strategy is typically deployed when one is neutral to bullish on the outcome of what is being purchased. But, it can also enable one to mitigate some losses (though not avoid losses altogether) en route to that more bullish outcome.

I’m looking for a stall in the markets, and think the near-term favors a deflating of the momentum that has propelled this market higher and faster than fundamentals currently support. 

Yet, my year-end outlook remains for higher highs (once the fundamentals and deflated expectations converge) so long as slow recovery doesn’t revert to no recovery.

To qualify what I mean by an “insurance policy,” note the following: The S&P 500 was down 112 days in 2009 (out of a total 252 trading days). On 84.8% of the S&P 500 down days, PBP lost less than the index.

We are maintaining our defensive stance toward growth; expecting to find ourselves in a stall. But a stall is where you rest your horse to prepare for the next ride; it’s not a permanent abode.

And even if the ride looks dismal at one stage of the journey or another, there are not enough reasons to not venture forth; over the most difficult decade for investors since the Great Depression, those who stayed in the index barn lost their way, while we found higher ground and greener pastures.

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