How To Beat The Market When The Market’s Not Moving

How To Beat The Market When The Market’s Not Moving
Andrew Rummer

over 2 years ago4 mins

  • When markets are treading water, you can boost anemic market returns by buying shares and selling call options on them.

  • The strategy has underperformed the US stock market for 12 straight years, but a rush of cash to some buy-write ETFs suggests some investors see that trend reversing.

  • If you’re tempted by the strategy, you can go it alone or simply buy into an ETF that’ll implement the strategy for you.

When markets are treading water, you can boost anemic market returns by buying shares and selling call options on them.

The strategy has underperformed the US stock market for 12 straight years, but a rush of cash to some buy-write ETFs suggests some investors see that trend reversing.

If you’re tempted by the strategy, you can go it alone or simply buy into an ETF that’ll implement the strategy for you.

Mentioned in story

US stocks have been hitting record high after record high, but data out of the country is starting to look less and less convincing. So if you’re one of the growing number of people who thinks share prices surely can’t have much further to climb, there’s one options-based strategy that could help boost your returns.

Why is this strategy getting more popular?

After rebounding strongly from the initial hit of COVID panic, US economic data has come in weaker than expected for the past two months. But despite these progressively more disappointing economic indicators, the US stock market has kept grinding higher, sending the S&P 500 to a fresh record this week.

Citigroup’s US Economic Surprise Index shows the weakest reading since June 2020
Citigroup’s US Economic Surprise Index shows the weakest reading since June 2020

This combination of elevated stock prices and lackluster economic fundamentals is pushing some investors toward more exotic ways of generating income from markets, even if stocks fail to climb much further from here. That might be why one such strategy – the so-called “buy-write” or “overwriting” strategy – has seen a massive pickup in investor demand this year.

What does the buy-write strategy involve?

To implement a buy-write strategy, you’ll need to buy shares while simultaneously selling call options – that is, selling a buyer the right to acquire the stock at a pre-agreed “strike” price at a date in the future – on those same shares. 

The sale of these calls allows you to generate a small additional income on your stock holdings, boosting your returns compared to just buying and holding the shares. The catch is that you don’t want the shares to overshoot the strike price you agreed to, because the people who bought the calls will then exercise their right to buy back the shares at a profit, and you’ll lose money.

That means there’s a balancing act at the heart of this strategy: choosing a call option strike price that’s not so near the current underlying share price as to leave the option at a high risk of getting exercised, while not so far above the share price as to make any income you receive from the sale vanishingly small. 

When does this strategy work best?

The strategy tends to pay off in markets that are simply treading water, because they’re less likely to hit the strike price and the options to be exercised by the person on the other side of the trade. For the same reason, it can also beat the market when stocks are falling. 

When stocks are climbing strongly, however, a buy-write strategy will tend to do worse than simply buying and holding shares. That’s because the market will keep breaching the strike price on those call options you sold, forcing you to sell stock to the options’ buyer at a price below the current market. 

The chart below shows how one of the most popular buy-write strategies – as tracked by the CBOE S&P 500 BuyWrite Index – beat the S&P 500 for most of the first decade of this century (indicated by a rising line). But it’s worth noting that it’s consistently underperformed since the great bull market that began in March 2009.

S&P 500 BuyWrite Index divided by the S&P 500 Index
S&P 500 BuyWrite Index divided by the S&P 500 Index

How do you execute the buy-write strategy?

If you’re confident in trading options, you can simply start selling call options on the stocks you own. If, for example, you own the SPDR S&P 500 exchange-traded fund (ETF) – a popular measure of US stocks with the ticker SPY – you could sell calls proportionate to the amount of shares you own. 

If, on the other hand, you aren’t willing or able to trade options yourself, there are widely available ETFs that can implement the strategy for you. The Global X S&P 500 Covered Call ETF (ticker: XYLD) and the Invesco S&P 500 BuyWrite ETF (ticker: PBP), for example, both track the aforementioned CBOE S&P 500 BuyWrite Index. The Global X ETF has seen $330 million in inflows so far in 2021 – far more than any year since the fund’s inception in 2013. 

Monthly flows into Global X’s S&P 500 Covered Call ETF
Monthly flows into Global X’s S&P 500 Covered Call ETF

Just remember, selling options is risky and can leave you on the hook for large losses if markets turn against you. And, as the past decade shows, buy-write strategies tend to underperform when stocks are rising strongly. But if you believe that stocks will struggle to climb much further from their already record highs in the face of weak economic data or company profits, a buy-write strategy might allow you to beat those struggling markets. 

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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