More ETF Innovation Coming To A Brokerage Account Near You

Innovation is great, using it incorrectly isn't.

I have written a few times about WisdomTree's increasingly innovative suite of funds. WisdomTree was one of the first niche fund providers which at first focused on dividend oriented strategies but have since expanded to include a wide swath of strategy types including various kinds of alternative strategies, currency hedging, bear market products and so on. Early on in their existence when I wrote for theStreet.com I got to meet some of the senior leadership as well as Jeremy Siegel and I got invited to some event they had at the New York Stock Exchange back in 2007, on June 14th apparently.

One alternative road they've gone down is with funds that sell puts. Under the hood of a fund I am favorably disposed but have been very cautious tactically based on how late we are in the cycle, yes, the bull could go on for years, I don't know but we are at nine and a half years and counting.

Selling put options is a bullish strategy or more precisely not a bearish one. When you sell a put you want the underlying stock or index (indexes can be a little trickier based on how they settle) to either go up or trade flat. The best outcome for a put you have sold is that it expires worthless and the way that happens is if the underlying stock does not go below the strike price of the put you sold.

As an example, a stock is trading at $100, you sell a put with a strike price of $95 for $2. Your put will expire worthless (again that is what you want as a put seller) if the stock stays above $95 (there's a little more to it but that is the basic idea). If the stock goes below $95 you will be assigned which means you are on the hook to buy the stock at $95 regardless of where it is trading in the market. If the stock is at $93 or $94 and you buy it at $95, that's probably not a big deal. What if you paid $95 for stock trading at $90 or $80 or $70? How about paying $95 for stock trading at $20? That last scenario is just about as bad as it gets and happened regularly to put sellers during the dotcom bust. In this scenario $7500 is just gone.

WisdomTree's first putwrite fund, the WisdomTree CBOE S&P 500 Putwrite Strategy ETF (PUTW), sells puts on the S&P 500 so that sort of 70% scenario is not realistic but the fund could have trouble with a crash depending on the particulars of that crash and it would also be very likely to get clocked in a bear market, one that rolls over slowly for a few months before then capitulating into a final panic. Here's a chart of how PUTW has done for the last two years, I'd say it has done very well.

It's not really a proxy for equities (it's not intended to be that) but is it kind of a proxy for the health of the bull market. When the S&P 500 got hit starting January 26th of this year, PUTW fell about 8% while the S&P 500 dropped about 10% through February 8th. The expectation should not be that selling put will offer bear market protection. The time to sell puts is right after a bear market.

ETF.com reported that WisdomTree is going to roll out a few more put write funds in addition to PUTW and a small cap put writing fund as follows;

  • WisdomTree High Yield Corporate Bond PutWrite Strategy Fund
  • WisdomTree Long-Term Treasury PutWrite Strategy Fund
  • WisdomTree International PutWrite Strategy Fund
  • WisdomTree Emerging Markets PutWrite Strategy Fund

The last two are straightforward equity strategies. Both emerging markets and foreign developed have struggled and while I don't know what the next year or two holds for them, after so many years of under performance for foreign stocks, a put writing strategy to accompany more traditional equity funds is not as risky as domestic equities which have had phenomenal performance for so many years.

Selling puts on long term treasuries is something I want no part of. Rates may not go up of course but I think that is by far the bigger risk. Anyone buying into that notion would not want to sell puts on treasuries. To be specific, this fund will sell puts on treasury ETFs so they are based on the price of the ETFs which is a proxy for the price of the bonds which I am saying has downside risk if rates rise. If these were selling puts on the yield of treasuries then selling puts would make more sense. Price and yield have an inverse relationship.

Selling puts on high yield bonds is a trickier strategy. High yield tends to be less interest rate sensitive but there is the added element of price moves based on credit spreads. If that is a new term to you then selling puts would seem to fly in the face of keeping things in your portfolio simple. This will be one I will need to follow to understand how it will trade but I suspect that it would be very vulnerable to a problem (recession) with the economic cycle.

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