Closed-End Funds With an Options Twist

04/07/2020 5:00 am EST

Focus: FUNDS

Michael Foster

Editor, BNK Invest

We're at a point where the market sold off so aggressively, and investors were expecting such bad news, that stocks may have hit a floor — and they may stay there as more bad news trickles in, because we're learning more about this crisis and how we can fix it, suggests Michael Foster, editor of CEF Insider.

It might sound crazy to expect a flat market today, because there's still a lot of uncertainty out there. So what can we do?

One way to profit in this environment is by selling call options, which give the buyer the right, but not the obligation, to buy a particular investment (a stock in this case) at a specified price within a specific time period. In return for that option, we get paid a premium by the buyer, which is ours to keep free and clear.

That best way to think about options is as a kind of insurance investors buy to protect other bets elsewhere, whether bullish or bearish.

We're not going to buy options ourselves, though; instead, we're going to let a seasoned pro do it for us, through an actively managed closed-end fund (CEF), which will then hand these premiums off to us in the form of cash dividends.

One option-selling CEF to consider now is the Nuveen S&P 500 Dynamic Overwrite Fund (SPXX), which yields 9.2%, one of the highest levels the yield has seen in the past decade.

his fund buys the stocks in the S&P 500 and sells call options on those holdings, passing on the cash it generates to investors as dividends. SPXX is also cheap, trading at a 12.5% discount to NAV.

Another option to consider is the Eaton Vance Tax-Managed Buy-Write Strategy Fund (EXD), which yields 11.3% and has a 9.4% discount to NAV.

Like SPXX, EXD sells call options, but it differs in that it focuses on a tech-heavy portfolio of large-cap names like Apple (AAPL), Microsoft (MSFT), Facebook (FB) and Alphabet (GOOG).

These are the kinds of companies people are using more than ever, now that they're self-isolating, making EXD both well positioned for the current market and the period we find ourselves in.

SPXX and EXD should be considered extremely short-term buys to squeeze income out of a CEF while betting on CEF discounts to narrow as the market comes to its senses.

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