I don’t think it’s much of a coincidence that covered call ETF’s have become such a phenomenon in 2011. The fact is that the environment has been almost perfect for such funds. Think about it. Thanks to the whole Greece & Europe debacle, we had high volatility, markets that have been very volatile, mostly to the downside. If you take the time to understand how Covered Call ETF’s work and how they are conceived, you will see that this has been a very friendly environment Perhaps even better would have been flat markets with everything else remaining the same but I think we still have to consider that the year has been very good to issuers and holders of these funds.
A Look At 2012
I think it remains likely that markets will remain very volatile next year. The fact is that two big problems remain:
#1-Europe – Sovereign debt issues remain at the front and center and it’s really not clear which if any solution will be able to calm things down in the long term. If governments such as Italy and Spain have to borrow at rates that are not sustainable, it will continue to create a lot of panic, what if scenarios. All of those things grouped together might not mean another big decline in the markets but it does means without a doubt a lot more uncertainty and volatility.
#2-Real Estate Prices: One huge problem all around the world but especially in the US is the continued decline in house prices which will continue to make the economic recovery a big challenge going forward. There are still millions of prices that could go become (or already are) under water and I think that will have a very negative impact on morale but also directly into the US markets and economy.
Why Is Volatility Good For Covered Call ETF’s?
Just a reminder in case you forgot, the main difference between a standard index fund and a covered call on the same index is that the covered call sells options on the stocks that it holds. Because of that, these funds usually hope for volatility which will mean they can get more by selling options. More income in the end translates into bigger dividends and better returns. On the other hand, very low volatility (generally seen in flat or rising markets) usually translates into lower priced options. The worst case scenario for covered call etf’s remain the fast rising markets which not only have low priced options but also means that the funds will have limited upside because the call options will be exercised.
Do you plan on holding covered call etf’s in 2012?