ALPS, a US-based provider of exchange-traded funds (ETFs), has announced the launch of the US Equity High Volatility Put Write Index ETF (HVPW) on the NYSE Arca. The fund provides investors with a regular income stream through the application of a put-write options trading strategy. This kind of strategy works well in trending bull markets, but can come under pressure when equity prices are declining.
The fund is based on the NYSE Arca US Equity High Volatility Put Write Index, an index reflecting the performance of a portfolio of written exchange-traded put options on highly volatile US stocks. Higher-volatility stocks command higher option premiums, thereby generating greater income for the strategy.
Put options are financial instruments that give the buyer the right, but not the obligation, to sell a specified quantity of a security at a set price, called the “strike” price, on or before an agreed upon expiration date.
The index, which was developed by the NYSE Arca, measures the return of a hypothetical portfolio consisting of exchange-traded put options which have been sold (or written) on each of 20 stocks and a cash position. The 20 stocks on which options are written are those 20 stocks from a selection of the largest capitalised stocks (over $5 billion in market cap) which also have listed options and which have the highest volatility, as determined by the NYSE Arca.
Each listed put option included in the index is an American-style option (i.e. an option which can be exercised at the strike price at any time prior to its expiration) with a 60-day term. The strike price (i.e. the price at which a put option can be exercised) of each put option included in the index must be as close as possible to 85% of the closing price of the option’s underlying stock price as of the beginning of each 60-day period.
The listed put options included in the index can be exercised at any time during prior to their expiration, but the index will reflect the value of each such option throughout the 60-day period as if the option is not exercised until its expiration. Each such option will automatically be deemed exercised on its expiration date if its underlying stock price is below its strike price. If the stock underlying the put option closes below the option’s strike price, a cash settlement payment in an amount equal to the difference between the strike price and the closing price of the stock is deemed to be made and the index value is correspondingly reduced. If the underlying stock does not close below its strike price, then the option expires worthless and the entire amount of the premium payment is retained within the index.
The fund intends to distribute, at the end of each 60‐day period out of net investment income and/or short‐term capital gains, an amount of cash equal to 1.5% of the fund’s net assets at the end of such 60‐day period. This equates to a income yield of approximately 9% per annum.
If the fund’s net investment income is insufficient to support a 1.5% distribution in any 60‐day period, the distribution will be reduced by the amount of the shortfall. While the fund only intends to make such distributions out of net investment income and/or short‐term capital gains, it is possible that in certain circumstances, a portion of a distribution may result in a return of capital (which is a return of the shareholder’s investment in the fund).
The strategy is not without risk. Investors assume the risk that the underlying referenced equities may close below their strike price, and investors also give up the upside on the underlying equities above the income the fund receives from selling the options. The potential return of the fund is limited to the amount of option premium it receives, while the fund can potentially lose up to the entire strike price of each option it sells. The fund’s risk of loss of one or more of its options is exercised and expires in‐the‐money may substantially outweigh the gains to the fund from the receipt of such option premiums.
The fund will be sub-advised by Rich Investment Solutions, a New York-based investment advisor, and has total annual operating expenses of 0.95%.