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Submitted by Dave Fry, ETF Digest on 11-09-2015

11-9-2015 8-45-27 PM

As investors continue to seek yield in a low interest-rate environment, we have periodically looked at product solutions ETF providers have developed to address this need in the market. One such product is the ALPS U.S. Equity High Volatility Put Write Index Fund (ticker HVPW).  While we  have written about HVPW a couple of times since its February 2013 launch, the recent diversification enhancements to the index it tracks and thus HVPW itself justify us writing about it again.

11-9-2015 8-50-40 PM1

HVPW was spearheaded and developed by Kevin Rich of Rich Investment Solutions (Rich Investment Solutions is also the sub-advisor to the fund). You may recall Rich came from Deutsche Bank where he created and launched commodity- and currency-based ETFs, such as PowerShares DB Commodity Index Tracking Fund DBC, PowerShares DB Agriculture Fund DBA, PowerShares DB US Dollar Index Bullish Fund UUP and PowerShares DB US Dollar Index Bearish Fund UDN, among others.

HVPW has maintained a steady 9% yield since launch and many consider it a “high-yield” type product. But it would be equally correct to categorize HVPW as an alternative  product, given its unique approach selling fully collateralized listed options. Since  launch HVPW has realized a volatility of approximately 2/3rds of the S&P 500, with a correlation of about 50% and a beta of roughly 0.30 (both with respect to the S&P500) as measured over this same period.

Recent Changes

We asked Kevin about recent changes implemented in October 2015 in the index and fund. Kevin characterized the changes as enhancements which don’t change the objective or strategy but are designed to lower exposure to single names and industry sectors and thus potentially improve overall performance. 

Increasing the number of underlying to names from twenty to forty and ensuring no single economic sector consists of more than 17.5% of the names (a move lower from the previous 50% sector limit), help potentially mitigate downside movements in single names and/or single sectors.

Ensuring selected underlying names have a price of at least $20 per share versus the previous  minimum of $10 per share allows the selection of underlying options with strikes closer to the target of 15%  out of  the money, a key objective of the index strategy. It may also avoid selecting stocks which may be under duress approaching single digit share prices.

As far as maintaining yield, Kevin says he sees the depth of high volatility names in the selection pool as more than adequate to support the index income stream and the changes as a whole  should help increase overall total performance.

In summary, Kevin feels the changes make the index and fund more robust while being consistent with the index strategy. The changes give the strategy more capacity and should be in the interest of investors and market participants in the products that track the index.  

11-9-2015 8-51-34 PM

 

Disclosure: The ETF Digest is long HVPW in the Growth & Income Portfolio.

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Submitted by Dave Fry on 07-07-2015

7-7-2015 3-24-52 PM

Investors in the broad U.S. equity market feeling uneasy or anticipating a correction may buy put options on the S&P 500 for protection. If the timing is right this “insurance” can be valuable. However, more often than not, we see the cost of this insurance, buying these puts, reduces returns. A better way to provide downside protection while also providing upside potential returns is by selling cash collateralized puts on the S&P500. This is exactly the strategy of the recently launched ALPS Enhanced Put Write Strategy ETF (ticker PUTX).

7-7-2015 3-22-42 PM Kevin RichPUTX was spearheaded and developed by Rich Investment Solutions, which is a sub-adviser to the new fund. Kevin Rich, founder and CEO of Rich Investment Solutions, came from Deutsche Bank where he created and launched the commodity and currency-based ETFs PowerShares DB Commodity Index Tracking Fund DBC, PowerShares DB Agriculture Fund DBA , PowerShares DB US Dollar Index Bullish Fund UUP,   and PowerShares DB US Dollar Index Bearish Fund UDN, among others. In 2013 ALPS and Rich launched the first put writing ETF called the ALPS U.S. Equity High Volatility Put Write Index Fund (ticker HVPW).

For many years CBOE has published two benchmark indices on at-the-money monthly put and call writing: the CBOE S&P 500 PutWrite Index (PUT), and the CBOE S&P 500 BuyWrite Index (BXM). There have been ETFs in the market tracking BXM for some time but not on PUT. As PUT has shown historically superior returns compared to BXM, there is recent renewed interest and new products coming to market offering investors access via ETFs.

With that in mind, we asked Kevin Rich a few questions about their new fund they just launched with ALPS.

Dave Fry: Good to talk with you again Rich, can you please tell us a about PUTX?

Kevin Rich: Thanks. PUTX is the first broad based put write strategy ETF. PUTX will sell one month at-the-money put options on the S&P 500 every month, or twelve times a year. It’s designed for investors looking for a defensive investment in the in the S&P 500. Selling monthly, at-the-money puts on the S&P500 has historically generated 18% - 21% option premium per year. While this premium represents close to the maximum upside return of the PUTX strategy, it represents the possible downside protection over the course of a year in a declining market.

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Submitted by Dave Fry and Kevin Rich on 03-24-2013


I’ve known Kevin Rich since he was the lead person responsible for the creation and launching of Deutsche Bank commodity and currency based ETFs in 2006. These included popular DBC (DB PowerShares Commodity Tracking ETF), DBA (DB PowerShares Agriculture ETF), UUP (DB PowerShares Bullish Dollar Index ETF) and UDN (DB PowerShares Bearish Dollar Index ETF) among others. Kevin left the bank several years ago to create and launch an interesting new ETF. Kevin’s new firm, Rich Investment Solutions, is the sub-adviser to a new fund off the same ALPS platform that has brought the select SPDRS series of ETFs and the Alerian MLP ETF AMLP.”

Dave: So tell us about your new ETF. What is it exactly?

Kevin: Thanks Dave, the fund is called the US Equity High Volatility Put Write Index Fund, the symbol is HVPW.  HVPW is an income generating fund.   The fund creates income by selling 15% out-of-the-money put options every two month on a portfolio of twenty stocks.  These stocks are selected by the index, which focuses on high volatility securities that also meet criteria on liquidity, market cap and sector concentration.   Investors in the fund receive the income by assuming the risk the underlying equities drop in value below the option strike price. Investors also give up the upside on the equities above the income they receive selling the options.

Dave: Interesting. I don’t think I’ve seen an ETF use put options in this way.  Where do you think it fits in a portfolio?

Kevin: Right, this is the very first “put-write” ETF in the market.  HVPW can be considered a substitute for a long equity position since HVPW profits when its underlying stocks increase in value.  HVPW can also be considered a liquid alternative investment since it provides exposure to equities through put writing.  And finally, HVPW can certainly be considered a complement to income generating funds (like dividend funds and high yield bond funds).

I’ve known Kevin Rich since he was the lead person responsible for the creation and launching of Deutsche Bank commodity and currency based ETFs in 2006. These included popular DBC (DB PowerShares Commodity Tracking ETF), DBA (DB PowerShares Agriculture ETF), UUP (DB PowerShares Bullish Dollar Index ETF) and UDN (DB PowerShares Bearish Dollar Index ETF) among others. Kevin left the bank several years ago to create and launch an interesting new ETF. Kevin’s new firm, Rich Investment Solutions, is the sub-adviser to a new fund off the same ALPS platform that has brought the select SPDRS series of ETFs and the Alerian MLP ETF AMLP.”

Dave: So tell us about your new ETF. What is it exactly?

Kevin: Thanks Dave, the fund is called the US Equity High Volatility Put Write Index Fund, the symbol is HVPW.  HVPW is an income generating fund.   The fund creates income by selling 15% out-of-the-money put options every two month on a portfolio of twenty stocks.  These stocks are selected by the index, which focuses on high volatility securities that also meet criteria on liquidity, market cap and sector concentration.   Investors in the fund receive the income by assuming the risk the underlying equities drop in value below the option strike price. Investors also give up the upside on the equities above the income they receive selling the options.

Dave: Interesting. I don’t think I’ve seen an ETF use put options in this way.  Where do you think it fits in a portfolio?

Kevin: Right, this is the very first “put-write” ETF in the market.  HVPW can be considered a substitute for a long equity position since HVPW profits when its underlying stocks increase in value.  HVPW can also be considered a liquid alternative investment since it provides exposure to equities through put writing.  And finally, HVPW can certainly be considered a complement to income generating funds (like dividend funds and high yield bond funds).

Dave: What would you say the investment rational is for this fund, in other words, why own it?

Kevin: Investors in this rate environment have been reaching deeper into high dividend yielding equities and lower grade fixed income products.  HVPW goes long t-bills and sells 2 month 15% out of the money puts on twenty us equity underlying stocks … so investors have 15% downside protection, diversification across twenty different underlying names, and low duration by doing 2 month options.  Further, as rates increase the yield from long portfolio of t-bills will accrue to the investors.  T-bills today are basically flat, but just go back to 2005 – 2006 and you saw yields around 5%.

Dave: Your fund sells options for income, is it the same as a buy-write strategy or buy-write ETF?                      

HVPW is similar to the buy-write ETFs, since you are generating income and giving up the upside of the underlying equities.  HVPW has the advantage over buy-writes in that it sells 15% out of the money puts, where buy-writes cannot give you a buffer on the downside.

Dave: Your fact card says the fund will distribute 1.5% six time a year, or 9% per year. Can you tell us how that will work, and how confident you are you can achieve that? 

Kevin: Good question as that is a differentiating feature of HVPW.  After each 60 day period, or 6 times per year, HVPW will distribute 1.5% of net assets as long as HVPW generated at least 1.5% premium during that period.  So if HVPW only generated 1% in a period that’s all it could distribute.  If HVPW generated 4% and some options were exercised against us for a loss of, say 3%, then it would still distribute 1.5%, and some of that could be deemed return of principal from a tax perspective. Also, as a 40 act fund, HVPW will have to distribute at least 98% of capital gain net income, so if after all the distributions are made during the year, if it still has additional income it may need to do an additional year end distribution.

Dave: OK, but how confident are you the fund will generate at least 1.5% each 60 day period?

Kevin: Well HVPW just launched and has no history, so we can only get a sense of this by looking at the index HVPW tracks.  That index launched in February 2012, so in the first full year of the index it showed approximately 3% premium generated per period Feb 2012 to Feb 2013.  Based on this we believe the 1.5% should be achievable, but there is no guarantee 

Dave: I assume the income from your fund will be taxed as income, right? Will investors get a K-1 or a 1099?

Kevin: Yes, we don’t give tax advice, but HVPW is an income strategy, so distributions will be income or short term capital gains, not long term gains.  Investors will receive 1099’s for HVPW, not K-1s

Dave: What market environments do you think your fund will thrive in?

 

Kevin: HVPW should perform well in upward trending and sideway trading markets.  In bear markets, because the fund is effectively short the stocks it has written options on, the fund may perform poorly.  However, because each option is written 15% out of the money, the fund may perform better than the broad market. 

 

Dave: Do you think because you select highly volatile stocks your fund has more downside risk, or “tail-risk” than say, owning the broad market or doing a put write on the broad market?

 

Kevin: While we have downside risk I would not say it is more risk, because remember we have a 15% buffer to the downside on each of the twenty names.  Diversifying across twenty names and the sector diversification in the index selection process also lowers the event risk, or “tail-risk “around a single name or sector.  Also remember, in a stressed market where the downside risk is higher, the implied volatility will also be higher, so the premium we generate selling the options should increase.  Another way to say this is the market prices the “tail-risk” into the options we sell, so we should be adequately compensated for any addition risk the find is taking on. 

 

Dave: I know your fund just launched, but from the index you track, can you tell how often the options expire worthless on average?

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