ETF BuyWrite invests in a global equity ETF portfolio built around peer reviewed academic research and then sells monthly out of the money calls on the S&P 500 index targeting 70% notional exposure.
In 2022 the strategies were down -20.9% and -9.5%, respectively. Steady PutWrite underperformed its Wisdom Tree CBOE S&P 500 PutWrite ETF benchmark(ticker: PUTW), while Steady BuyWrite outperformed its Vanguard Total World Stock ETF benchmark(ticker: VT). Both strategies performed within the range of expected outcomes considering the losses experienced by popular stock and bond indices. For example, the Vanguard S&P 500 ETF was down -18.17%, and the Vanguard Total Bond Market ETF was down -13.11%. This was the worst year for the S&P 500 since 2008, and the worst year ever for the total bond market ETF and underlying benchmark index dating back to 1976. It was a rough year in the markets for long term investors.
Steady PutWrite
Steady PutWrite underperformed its benchmark in 2022 for two primary reasons:
Leveraged notional exposure to put writing in a year where put writing lost money. Collateral invested in intermediate term bonds instead of short term T-bills in the worst ever year for the total bond market.
When reflecting on a losing year, the best thing to do is to break down a strategy into its component parts and ask if our beliefs that went into the original creation of the strategy have changed. Questions:
Do we still believe that selling monthly at the money puts on equity indices will have positive returns going forward? Do we still believe that intermediate term bonds will outperform T-bills going forward? Is the chosen level of risk exposure in the strategy still appropriate?
We believe the answer to all 3 questions is still a resounding yes.
Writing puts on the stock market has positive expected returns because insurance comes at a cost to buyers over the long term. Writing puts is the equivalent of selling stock market insurance, and occasionally we must pay out claims. If writing puts didn’t have positive long term expected returns, hedging a stock portfolio would be free. This simply cannot be in an efficient market.
Intermediate term investment grade bonds include interest rate and credit risks that are not present with short term T-bills. Investors demand long-term compensation to bear these risks, knowing at times duration risk shows up and causes losses like happened in 2022. Since bond markets quickly price in all known information, trying to actively time term risk is difficult if not impossible as evidenced by the consistent long term failure of actively managed bond funds.
The strategy losses in 2022 were large but still within the range of historical and expected outcomes. For example, our backtesting shows that the strategy would have lost more money in 2008 than it did in 2022, which can be seen on the strategy overview page. Followers can easily reduce the risk if desired by trading fewer contracts and by swapping some of the bond ETF’s for cash. For our published performance where we want to compound returns over the long term at a double digit rate, we’ll stick to our discipline and keep our risk level Steady in 2023 to make sure we can fully participate in the eventual recovery.
ETF BuyWrite
ETF BuyWrite outperformed it’s benchmark due to “tilts” towards small cap and value stocks, and due to profits from selling S&P 500 calls every month. The strategy is designed to compound capital at a similar expected rate of return as Steady PutWrite over the long term, but is more suitable for investors who are passive or who are using an IRA. Value stocks continue to look historically attractive relative to growth stocks going into 2023, as do Foreign stocks relative to US stocks, and we have confidence that our chosen portfolio o fETF’s will continue to outperform its benchmark. The short call technique within the strategy acts like a covered call providing us a downside cushion while retaining the vast majority of the upside exposure since we write out of the money calls against 70% of the portfolio value.
Conclusion
2022 was challenging but provides us with an optimistic outlook for the new year. Bond yields have more than doubled from last year, option premiums are attractive, and global equities appear reasonably to attractively valued. If you have stuck around for the risk, you might as well stick around for the rewards too. Good luck and best wishes in 2023!
Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides financial planning and investment advice to clients all over the United States. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University. Jesse manages the Steady PutWrite service, and regularly incorporates options into client portfolios.
