"Markets have false sense of security"

David_Snowball

The Wall Street Journal might be channeling their inner-Devesh. They note that there's been a flood of money into options-backed funds and ETFs, but the news is not all good. Jon Sindreu (3/8/2024) writes:

If you bought so-called structured products recently, you have plenty of company. But is precisely their popularity that could make them - and perhaps the entire stock market - riskier than they seem ... The bargain often appeals to less-sophisticated investors who otherwise might not dabble in complex derivatives. For banks they bring in fat fees.

There follows a discussion of one class of derivatives, called "autocallables." At base, banks are the counterparties in the autocallable trade, so they have an incentive to hope for market stability which, in part, is caused by their own need to busy "insurance" against their exposure to these options. Sindreu summarizes:

So autocallables look attractive because the stock market is calm, but the market is calm because people are buying so many autocallables. The feedback loop is reminiscent of the one created by funds that directly wagered against volatility back in 2017 and 2018. When a bout of selling broke the cycle, banks stopped hedging, volatility exploded and the market tanked.

His conclusion: you shouldn't trust the Vix as a gauge of potential trouble. Quoting Jeffrey Yu of BNY Mellon, "Low volatility begets low volatility. Until something goes wrong."

Interesting article, though much of the mechanics of the trade are a bit over my head. In any case, it's offered for what it's worth.

BaluBalu

Counterparties by their actions increase volatility both when coming off the bottom and the top.

PRESSmUP

Jon Sindreu mentions JEPI...$32B AUM and very quickly.

I do recall a recent conversation with Kevin Simpson of DIVO fame, indicating that high volatility enhances the distribution potential of running a covered call ETF...FWIW.

JD_co

AI, semiconductors and Fed rate-cut mania. Is Bitcoin still hot? Yep. The markets can only go up.

Old_Joe

Yep- sure thing, for as long as I can remember. So do Boeing 737s. What could possibly go wrong?

Devo

The options market is big, opaque, listed, Over-the-counter (private transactions), complex and because of the option expirations, constantly changing. It's hard to get a sense of just the trees, let alone the forest. Huge doses of humility are called for when trying to analyze and predict the world of options.

WABAC

Devo said:

The options market is big, opaque, listed, Over-the-counter (private transactions), complex and because of the option expirations, constantly changing. It's hard to get a sense of just the trees, let alone the forest. Huge doses of humility are called for when trying to analyze and predict the world of options.

I appreciate the education you gave me on options a little while back.

I would be interested in your opinion of DIVO.

racqueteer

Hmmm... Devo on DIVO... Has a nice ring to it!

WABAC

racqueteer said:

Hmmm... Devo on DIVO... Has a nice ring to it!

I resisted the temptation.

But now,

"Crack that whip."

Devo

Will try Sir.

yogibearbull

Well, there are @Devo, DIVO, Davo, Davos.

DIVO is a call-writing funds. It's lags the industry giant JEPI and is more expensive too. In the up markets like this, it may be covering its calls, or its stocks are being called away. But that is the deal - you give up some upside for options income. Here are the charts for JEPI, DIVO, IVV/SP500.

https://stockcharts.com/h-perf/ui?s=JEPI&compare=DIVO,IVV&id=p47538115979

WABAC

Lipper categorizes DIVO as an equity-income fund. In that category it is an MFO "Great Owl." At the present time it is writing calls against four stocks in its portfolio rather than the entire S&P 500.

For me, JEPI does not have enough of a track record. And I am not sold on the idea of writing calls against entire indexes.

If I set MFO premium to a five-year window, DIVO's APR out performs all of the other ETF's in the Options Arbitrage category, and with respectable Martin and Sortino scores. Over its seven year history it outperforms its competitors, and has the best Martin and Sortino scores. If one only looks back a year, then DIVO and JEPI are getting smoked by the majority of etf's in the category.

For my purposes, DIVO was competing with AMFFX rather than JEPI. DIVO is cheaper than AMFFX. DIVO versus AMFFX.

Yet another dinky linky.

BaluBalu

@wabac,

I was not familiar with AMFFX and so looked it up. Still can not figure out why you compared it with DIVO. Please say more / share more.

P.S.: For me, derivative income equity funds are a different animal than historical traditional equity income funds. But there may be similarities between them that may be compelling for others and i would like to understand.

WABAC

@BaluBalu, conservative portfolio, low standard deviation, low Beta, low R-squared; and not dissuaded by M* calling it a Derivative Income fund.

Here is what the prospectus has to say about that part of their strategy:

CWP seeks to lower risk and enhance total return by tactically selling short-term call option contracts on some, or all, of the Equity Securities in the Portfolio. . . . Unlike a systematic covered call program, CWP is not obligated to continuously cover each individual equity position. When one of the underlying stocks demonstrates strength or an increase in implied volatility, CWP identifies that opportunity and sells call option contracts tactically, rather than keeping all positions covered and limiting potential upside

That doesn't sound crazy to me. I can't speak to why Lipper considers it an equity-income fund.

BaluBalu

Thanks @wabac. I experimented with derivative income (did not learn the term from M*) products. There can be a place in a portfolio for these but I decided to keep them out to keep the place open. Between JEPI and Divo, I liked Divo for the part you quoted.