8 November 2019
Buy-write overlay strategies are well-placed to capitalise on these tumultous conditions by adding a consistent and diversified source of real return to investor portfolios. It’s one of the most basic forms of derivative overlay strategy, where equity is owned, and a corresponding call option is sold over the underlying position. A buy-write strategy effectively replaces ‘expected but uncertain’ capital gains with far more consistent income streams, while still receiving all dividends (and franking credits on the ASX 200).
A buy-write strategy differs from a typical long-only investment strategy in that it converts a large component of return to income. Typically, most investment returns from owning equities are delivered via growth in capital, with a smaller component delivered via income (namely dividends). A buy-write strategy reverses this relationship, with most return coming from income. This conversion to income fundamentally changes the path of investment returns, as income return is more certain, less volatile and protects against losses. However, as return from income is capped, it also causes the strategy to underperform equity markets when they are strong. Over time, total investment returns from systematic buy-write strategies have proven very similar to equities, albeit with a different shape that is reflective of a lower-risk, income-driven return profile... read more.