Closed-end covered call funds

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Indyone's picture
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Joined: 2005-05-30

I came across this class recently in an article and was wondering if anyone is using these or familiar with them?  Looks like they have high yields for income-hungry clients (9-10%), and possess some downside protection from poor equity markets.

Starka's picture
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Joined: 2004-11-30

Indyone wrote: I came across this class recently in an article and was
wondering if anyone is using these or familiar with them?  Looks like they
have high yields for income-hungry clients (9-10%), and possess some
downside protection from poor equity markets.

I use covered calls in my book. Like you, I've only recently learned about
these funds, and am doing some due dilligence about them. That said, it's
an intriguing idea, particularly if we have a pullback or a full blown
recession.

Lex123's picture
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Joined: 2006-10-26

Don't be fooled. It's just another Wall Street gimmick.  Smoke and mirrors and lots of leverage. Just ask an older broker in your office. They had these things in the 80's. Rest assured, like all closed-ends, they will be trading a deep discounts someday and the income won't feel so good with a rapidly eroding NAV.

AllREIT's picture
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Joined: 2006-12-16

Lex123 wrote:Don't be fooled. It's just another Wall Street
gimmick.  Smoke and mirrors and lots of leverage. Just ask an
older broker in your office. They had these things in the 80's. Rest
assured, like all closed-ends, they will be trading a deep discounts
someday and the income won't feel so good with a rapidly eroding
NAV.

These funds were tried in the early 1980s when money market yeilds were
10%+. It doesn't work, not then and not now. It is absurd for any of
these funds to be trading at premium to book.

Over time NAV gets erroded becuase the the calls limit the upside to
the option premium while the downside is all there. Since the fund pays
out all of its option premium, its as if the fund's NAV has a downward
ratchet.

Over time as NAV dissapates, the dividend will have to be cut because
there is less stock to write on as the portfolio gets called away and
reinvested.

As soon as the dividend gets cut these things go into free fall, and clients will not be amused.

troll's picture
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Joined: 2004-11-29

I've known about them since being introduced to the Kelmoor open end funds about 5 years ago.  Although I use covered calls from time to time with specific stocks, I've always been suspicious of them...

NOFX's picture
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Joined: 2006-09-22

There are quite a few out there with no leverage - NFJ,ETG, ETW, IGD.  You will find, if you look at the chart from Q3 and Q4 2005, that these funds don't actually protect you in a soft market.  I bought quite a bit on the IPO of all 4  (check out ETG in 2004).  Unlike an open end fund, they trade more on supply and demand of the funds stock - with little or no relation to the NAV.
Having said that, go on to "closedend-funds.com" and search for funds trading at a discount to NAV.  It's a good place to start looking for relative value.  Last year at this time there were a lot of closed end funds trading at big discounts not only to NAV but also to their original offering price - I crossed my fingers and doubled down.  Including div. reinvestment I have a lot of clients who got a total return of 20%+ in '06 in the 15% bracket.
Make a list of the strategies that you believe in, put it on watch on Googlefinance or Yahoofinance and  wait.  Especially watch the funds that came public in the past year that haven't blown up yet.  They will.  When they do - wait and buy them when they are approx. 10 -20% off of their offering price.  9-10% yield and the price will recover over the following 12-24 months.
Remember: Confucius say: "Only monkey pick bottom"

AllREIT's picture
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Joined: 2006-12-16

NOFX wrote:There are quite a few out there with no leverage -
NFJ,ETG, ETW, IGD.  You will find, if you look at the chart from
Q3 and Q4 2005, that these funds don't actually protect you in a soft
market.  I bought quite a bit on the IPO of all 4 
(check out ETG in 2004).  Unlike an open end fund, they trade more
on supply and demand of the funds stock - with little or no relation to
the NAV.
Having said that, go on to "closedend-funds.com" and search for
funds trading at a discount to NAV.  It's a good place to start
looking for relative value.  Last year at this time there were a
lot of closed end funds trading at big discounts not only to NAV but
also to their original offering price - I crossed my fingers and
doubled down.  Including div. reinvestment I have a lot of clients
who got a total return of 20%+ in '06 in the 15% bracket.

These covered call funds tend to attract a sort of naive yeild
chaser, that can't understand that it is impossible to pull 10% yield
out of anything safely.

The main CEF's that I like are the various state muni-CEFs. Once
these trade at a stable discount, you can get a nice stream of muni
income with little bounce to the shares.

Indyone's picture
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Joined: 2005-05-30

I think they could work in a neutral to slightly rising market.  I also think the new breed is considerably different than the variety that gained notoriety in the 70's and 80's.  The new funds tend to put more emphasis on stock-picking and don't necessarily write calls on the whole portfolio.  Also, I've had more than one investment that I pulled a high dividend from and did OK on.  The most recent is OTT which I bought earlier this year at $16.  It's possible if you know the story behind the investment.
All comments appreciated...I'm not using them yet, but am still looking...

AllREIT's picture
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Joined: 2006-12-16

Indyone wrote:I think they could work in a neutral to slightly rising
market.  I also think the new breed is considerably different than
the variety that gained notoriety in the 70's and 80's.  The new
funds tend to put more emphasis on stock-picking and don't necessarily
write calls on the whole portfolio.

Nope, instead they write index calls, and hope to gain alpha from
picking stocks to perform better than the index while only losing the
upside of the index. As NAV begins to errode, they will write calls on
more of the portfolio to keep the dividend. Again, the downward ratchet.

Lipstick on pig. I think selling covered calls can be good idea if done as a tactic not as a strategy.

Quote:Also, I've had more than one investment that I pulled a high
dividend from and did OK on.  The most recent is OTT which I
bought earlier this year at $16.  It's possible if you
know the story behind the investment.

OTT is an IDS, it trades a unit of a share of stock and a high yield
bond together. The "dividend" is like 50% QDI and 50% bond
interest.  There are a few companies with these securities out
there, and at least one of them is trying to get rid of that structure.

Wireline telephone companies like EQ tend to have high dividends. The
key question is how are you getting the yeild and is it sustainable.

Indyone's picture
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Joined: 2005-05-30

You have a good understanding on most of these issues, but you are generalizing on this class of ETFs and you're wrong about at least two managers I'm looking at.  There are no index calls involved.  The calls written are on a portion of the underlying portfolio.  No calls are written on the stocks the manager feels have the greatest potential.  Because part of the portfolio is uncovered, I don't have as much concern about the NAV erosion issue.
Yes, OTT is an IDS, so part of the dividend is not qualified.  That doesn't bother me, and I'm pleased with the total return.  Consolidation is a real possibility and that OTT may very well be taken out for more upside.  Is this sustainable?  I think it is for the foreseeable future and the day I don't, I'll sell it.  It's a small part of my portfolio and I'm mostly having some fun while making a little money.  The bottom line is, turn over a few rocks and every once in awhile you get lucky.

NOFX's picture
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Joined: 2006-09-22

Take a look at where NFJ is today vs. 1 year ago.  All the paralyzing analysis in the world doesn't change the fact that you have a LT cap. gain of 10% + and a dividend over 10% from where you bought it.  Reinvesting, it was an easy 20%.  Numbers are about the same for ETW.  Over analyze it all you want - buy a quality closed end after the penalty bid is gone and all you have to do is wait.  Most of the big name closed ends are not like the "term trusts" of the early 90's anymore.  I'm looking for this years bargain now...

BondGuy's picture
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Joined: 2006-09-21

AllREIT wrote:
 
These covered call funds tend to attract a sort of naive yeild chaser, that can't understand that it is impossible to pull 10% yield out of anything safely.
The main CEF's that I like are the various state muni-CEFs. Once these trade at a stable discount, you can get a nice stream of muni income with little bounce to the shares.

This is interesting stuff. Let's talk about this for a moment. I have to take issue with your use of the term "naive yield chaser." First, aren't we all chasing yield? I mean, call it what you will, but we're all going after yield. Next, covered call writing isn't safe and those who invest in it are naive to think differently? Last time I checked which was 10 seconds ago, covered call writing was very safe. Of course safety is a realtive thing. But, I'd put it up against your muni CEFs any day. Which by the way, most real muni buyers wouldn't touch, high yield or no high yield, etc. Also, the way you frame that BIG 10% yield on some of covered call funds, is like it's all the yield in the world. It's not. In fact, compared to most well run CC programs, that kind of return will get you fired. But it's as good as these funds can do because of the lessons learned in the 80s. Lastly, don't mention safety, safe, safely, or any other words with that meaning in the same post with any type of muni fund especially CE muni funds. Doing so, and you are the one who is coming off looking naive.
Ok, now you want to take my head off, i know. Think first. If I show this post to ten bond traders they are all going to agree with me. Every bond trader will agree. People who buy bonds aren't interested in chasing the highest yields available. They don't care how clever you CEF muni manager is and how long they've been around etc. They're interested in one thing and one thing only, and that is, not losing their money. One look at 94 or 98 tells you bond funds aren't that safe a place. Investors who bought bonds before those collapses got , or will get 100% of their money back. Fund owners, mostly, are out of luck. Some in a major way. Neither, 94 or 98 were in any way predicted or predictable. Everyone was in the pool and boom! Somebody pulled out the plug and we all started circling the drain.
If you 've got money invest, Ok, you want to put into a fund go ahead. But if you want safety, buy the bond instead. The fixed side should go into bonds, not funds. As naive as it sounds.

AllREIT's picture
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Joined: 2006-12-16

Indyone wrote:You have a good understanding on most of these
issues, but you are generalizing on this class of ETFs and you're wrong
about at least two managers I'm looking at.  There are no index
calls involved.  The calls written are on a portion of the
underlying portfolio.  No calls are written on the stocks the
manager feels have the greatest potential.  Because part of the
portfolio is uncovered, I don't have as much concern about the NAV
erosion issue.

You got me, I was thinking about ETY, which has a split
portfolio/index call strategy. It's as if Eaton Vance took every
fashionable gadget and stuffed it into a 2.6 billion dollar sausage.

I have no problem with occasional covered call writing. For example
right now, I think we are close to a market top, so selling 2% OTM
calls on SPX would be reasonable.
Quote:Yes, OTT is an IDS, so part of the dividend is not
qualified.  That doesn't bother me, and I'm pleased with the total
return.  Consolidation is a real possibility and that
OTT may very well be taken out for more upside.  Is this
sustainable?  I think it is for the foreseeable future and the day
I don't, I'll sell it.

I think in OTT's case it works, AFAIK Coinmachine Service Corp (DRY/DRA) is trying to get rid of its IDS.

There used to be some bargains in this sector of old-tyme telecom. I
like EQ (Sprint's Landline business), though its not as cheap as it
used to be.

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