| Last week, our founder Brent Kochuba attended the EQ Derivatives conference in Las Vegas. The conference attracted attendees from various backgrounds, including pension funds, sell-side firms, exchanges, and fund providers. One of the hottest topics over the two days of presentations was the proliferation of systematic call overwriting. The interest in this discussion was driven by the growing demand for call overwriting, also known as “Derivative Income” products, which have grown to over $120 billion in assets. |
 The Impact of Systematic Overwriting There are two primary impacts related to systematic overwriting: >Potential dealer hedging impacts >Benefits to the investing public In this piece, we will focus on the second impact. Dealer Hedging Impact Regarding dealer hedging impacts, we recently argued that these flows help mitigate S&P 500 volatility. You can read more about it and watch the associated video presentation here. A Look Into Derivative Income Funds Why have assets grown in this sector? “Investors love the yield,” was a primary reason cited by several ETF issuers in the panel: “The Continued Rise Of Option Income ETFs — Are They A Risk?” Several times during the panel, issuers highlighted the double or even triple-digit yields these products offered. Most of the yield in these Derivative Income products is driven by systematically selling 1-4 week calls against some form of long stock position. These funds sell a certain number of calls, at generally similar prices/exposures, on their designated roll dates, making them automated. While many of these products offer large yields, are these high yields beneficial for investors from a total return perspective? It appears not. Below is a year-to-date plot of JEPI (candles), the largest overwriting ETF by assets, vs. the SPY ETF (yellow). Even when incorporating the compounding of dividends, JEPI has underperformed SPY by 50%.  Next, let’s look at NVDY, the “YieldMax™ NVDA Option Income Strategy ETF,” which sells weekly calls against an NVDA stock position. NVDA stock this year is up a blistering 120%, while the NVDY overwriting ETF is only up 80%. So, while you are collecting a large 47% yield with NVDY, the ETF is underperforming the stock itself by nearly 33%.  Other Income Funds There are other income funds which focus on hedging structures like collars, and even selling 0DTE puts. The “Defiance S&P 500 Enhanced Options Income ETF,” tickered “JEPY,” sells 0DTE, cash-settled puts. This means your upside on any given day is limited to the premium garnered from selling a slightly out-of-the-money SPX put. However, the investor is exposed to the unlimited downside of the S&P 500 for the day. Here you can see that this fund underperforms the SPY by nearly 50%, despite its 49% yield.  Accordingly, JEPY creates a payoff distribution that is very negatively skewed. The maximum you can generally earn on a given day through JEPY is 50 basis points, which is the value of the zero DTE put sold each morning. Conversely, you could easily lose several percent should the S&P 500 trade lower, sending the short zero DTE put deep into-the-money.  How to Overwrite/Sell Calls While we highlight issues with systematic call overwriting, we believe that call overwriting can be a great tool for traders to generate alpha, gain income, and/or reduce risk. This is typically best done when call prices have increased sharply and may be nearing extremes. Consider the plot of 1-month skew in SLV (the Silver ETF) from SpotGamma’s Vol Dashboard. You can see that 1-month IV (teal line) is well above its 90-day range (teal shaded area). Further, you may note that out-of-the-money calls had much higher IV’s relative to more at-the-money options. We refer to this as an “elevated call skew”, which is often a sign of heavy demand for long calls. Taken together, this informed us on 5/21 that SLV calls were relatively expensive, allowing traders to enter into short call positions at objectively elevated prices.  Following SpotGamma’s flag of elevated SLV IV’s, the SLV ETF retraced over 5%. This was a prime example of how to evaluate implied volatility data in order to more tactically sell calls at advantageous prices, vs systematically selling calls regardless of market conditions.  Gain an Edge with SpotGamma’s Volatility Tools SpotGamma’s advanced volatility tools give traders an edge with call selling by providing critical insights into market conditions. Our tools help identify when call prices are inflated, allowing you to strategically enter short call positions at optimal times. This informed approach maximizes your potential returns and minimizes risk, giving you a significant advantage in the market. Sign up today if you want access to our tools and to follow our daily analysis of the opportunities that the market is bringing. |
