We believe the market has the potential to produce a powerful move to the upside; in keeping with ou...
Two Options to Ride Out the Storm
10/02/2008 11:00 am EST
Richard Lehmann, editor of ISA ETF Investor, says closed-end “buy write” funds are good investments in volatile markets.
Although we see the stock market in general as still vulnerable to a recession next year, the financial sector and certain closed-end funds represent attractive buys now.
With the federal government proposing to take over up to $700 billion of illiquid mortgage instruments, the large banks will see selling these instruments to the government represents a way of strengthening their balance sheets. Thus, money center banks, such as Bank of America (NYSE: BAC) and Citigroup (NYSE:C), would benefit the most from the bailout.
A second sector that should do well are income-oriented closed-end funds. The recent market has not been kind to these funds, and many are sporting double-digit yields and double-digit discounts to net asset value. This situation will not last.
We believe the “buy-write” strategy is the best way to take advantage of volatile markets. The main advantage is that in a down market, income is still generated by the option premiums, and they serve as a break during sharply declining markets.
The Eaton Vance Enhanced Equity Income Fund II (NYSE: EOS) is a closed-end fund employing the option-writing strategy. The fund is currently trading at $14.20 and yields 12.3%. The fund’s typical discount from net asset value over the past year was 6.54%, but it now trades at [more than] a 12% discount. (It was down 23% in the past year, as of last week—Editor.)
The fund seeks growth through capital gains and dividend income in addition to option income. [It] invests 27% of its funds in companies involved in information technology and 15% in health care companies.
International markets have followed the US market in the recent turmoil. As a result, option premiums have risen to match the volatility of the markets. There are many global “buy-write” funds that take advantage of high option pricing and that trade at discounts to their net asset value.
The ING Global Equity Dividend & Premium Opportunity Fund (NYSE: IGD) has the lowest expense and PE ratios and one of the highest yields compared to other [global “buy-write” funds]. It’s trading at a [roughly 20%] discount to its net asset value and yields 16.21%. (It was down almost 39% over the past year as of last week—Editor.)
The discount allows for a declining market and the promise of a 20% gain if the fund trades near its actual value. In addition to trading at a substantial discount, the difference between its current discount and its 52-week average discount is larger than other buy-write funds. The average discount over the past year was 5.19% compared to its current 20%. In addition to selling calls, the fund may also buy puts to protect against possible losses, an important safeguard in volatile markets.
Related Articles on FUNDS
The three managers of Akre Focus Retail Class (AKRE) liken their investment process to a “thre...
Essent Group Ltd. (ESNT) is legally domiciled in Bermuda; its sole business is providing private mor...
My Top Pick for conservative investors for 2018 is Templeton Emerging Markets Income Fund (TEI), a c...