The torpor in U.S. equities is proving a bonanza for traders employing an options tactic designed to capitalize on dead markets.
For the first time since 2011, speculators using the buy-write strategy -- selling bullish options while holding the underlying stock to amplify gains -- are beating the Standard & Poor’s 500 Index. The Chicago Board Options Exchange S&P 500 BuyWrite Monthly Index has risen 6 percent this year, beating the 1.7 percent gain in the broad-market gauge.
Traders have taken notice. They’ve flocked to the PowerShares S&P 500 BuyWrite Portfolio, an exchange-traded fund tracking the options tactic, and pushed shares outstanding to a record in May. The ETF has climbed 3.5 percent this year.
“A churning market is the buy-write index’s best friend,” said Mark Sebastian, options trader and founder of Option Pit, a Chicago-based education and consulting firm. “In a market where’s there’s not a lot of large swings or the S&P 500 doesn’t go anywhere on a month-to-month basis, it’s going to outperform.”
U.S. stocks’ narrow band has allowed traders to sell both bearish and bullish options without having to exercise them. The S&P 500 has traded in a 90-point range since February, fluctuating between gains and losses as investors digested weakening earnings, turmoil in Greece and China and the withdrawal of Federal Reserve stimulus.
At the same time, the cost of options has increased, allowing buy-writing traders to collect bigger premiums when they sell. The CBOE Volatility Index, a measure of S&P 500 hedging costs, has averaged 15.07 this year, higher than any since 2012. It dropped 14 percent to 13.44 Tuesday.
The S&P 500 rose 0.7 percent to 2,108.57 at 4 p.m. in New York.
Stocks have calmed down from the previous three years, a period of almost unrelenting appreciation that rivaled the fastest advances since the 1990s technology bubble. From 2012 to 2014, the S&P 500 rose an average of 10 percent more than the buy-write gauge as the rapid gains sent calls into the money and reduced revenue from selling options.
“The fundamental drivers of buy-write’s underperformance - - Federal Reserve bond-buying and zero interest rate policies -– is coming to an end,” Nicholas Colas, chief market strategist at Convergex Group LLC, wrote in a note Tuesday.
Buy-writing could lose its appeal if equity gains accelerate. Wall Street forecasters predict the S&P 500 will jump 6.6 percent from Tuesday’s closing level through the end of the year, according to a July 1 Bloomberg survey.
Tuesday was an example of a day when conditions for buy-write were less than ideal. The S&P 500 rose 1.2 percent for its best day in more than two weeks, while the CBOE buy-write index added 1.1 percent, underperforming the broader market.
“The only way this strategy doesn’t outperform is in a runaway up market,” said Stephen Solaka, managing partner of Belmont Capital Group in Los Angeles, which oversees about $250 million in assets and offers a buy-writing strategy for clients. “In years like 2013, you’re just not getting much premium for your calls.”