DIAX - BXMX: Discount Opens Up

2023-08-22 11:44:54 ET

Summary

• The Nuveen S&P 500 Buy-Write Income Fund is currently trading at an attractive discount, dropping from the premium when we last covered the fund.
• The fund aims to mirror the S&P 500 Index and generates options premium, with a nearly 100% overwrite.
• BXMX has seen its distribution change many times in its history, but the latest payout seems to be at a reasonable level where it could be maintained for now.

Written by Nick Ackerman, co-produced by Stanford Chemist.

Nuveen S&P 500 Buy-Write Income Fund ( BXMX ) was trading at a premium the last time we provided an update . Today, the fund has fallen to a discount amid an overall market dip as yields have been on the rise. This could create an opportunity for an investor to gain exposure to this fairly straightforward fund.

The fund looks to mirror the S&P 500 Index - through a smaller number of positions - then writes calls against the same index. This creates a situation where the upside could be capped, but it offers a bit of downside protection due to generating options premium. This option premium then also helps support the fund's quarterly distribution payout.

The Basics

• 1-Year Z-score: -2.13
• Discount: -4.90%
• Distribution Yield: 7.28%
• Expense Ratio: 0.91%
• Leverage: N/A
• Managed Assets: $1.458 billion
• Structure: Perpetual

BXMX's investment objective is to "seek attractive total return with less volatility than the S&P 500 Index..." They intend to achieve this through "...investing in a global equity portfolio that seeks to substantially replicate the price movements of the S&P 500 Index and by selling index call options covering approximately 100% of the Fund's equity portfolio value with a goal of enhancing the portfolio's risk-adjusted returns."

The fund's expense ratio is relatively low for a closed-end fund, which is often the case with call-writing funds. That's another potential reason why they can be quite popular with income-seeking investors in the CEF space. On top of this, they aren't leveraged, which can be another benefit during volatile times when other CEFs get hit particularly hard.

No leverage is also becoming particularly attractive with rising interest rates. Leveraged funds have to grapple with rising borrowing costs in this environment. Most leveraged funds have hedged against rising rates, but as long as rates remain high, it could be something they'll have to deal with eventually in the future.

Performance - Discount Appears to Present Opportunity

Since our last update, the fund has provided an essentially flat total return during this period. At the same time, the S&P 500 would have delivered around a 10.4% return.

This isn't only the options limiting upside here at play, though. As noted, this is also being driven by the fund going from around a 3.44% premium and now going to a nearly 5% discount. In fact, if we look at the total NAV return performance of BXMX relative to the SPDR S&P 500 ETF ( SPY ) , BXMX has put up virtually similar results at this time. The total NAV return performance here is important because that's how the actual underlying portfolio is performing.

Thus, this is where the opportunity for BXMX arises with a diverging share price relative to its NAV.

It's this, what a reader had referred to in the past as an alligator mouth, that is opening up and creating the discount for the fund. However, we can also see that the price and NAV have both slipped sharply recently due to the broader market sell-off as yields ticked higher.

We have now crossed below the average for the discount itself relative to BXMX's history during this period. However, trading at a fairly deep discount is pretty common for this fund on many occasions. That's why I wouldn't necessarily feel comfortable saying this is a can't-miss opportunity or anything, as a ~10%+ discount isn't rare either.

Nevertheless, it could still create a solid opportunity for a long-term income investor.

Distribution - Many Adjustments

One thing that most CEF investors don't tend to care for is a lot of changes in the distribution. Well, unfortunately, it would appear that BXMX has done just that over its history.

They've adjusted up and down - though the downs were a lot more severe and plentiful than the couple of boosts. With the 2018 increase proving to be fairly short-lived; it seemed to be mostly poor timing with that raise. Shortly after that bump higher came Q4 2018, the broader market corrected, which saw them cut it back down again.

I certainly wouldn't call this a steady payout by any means. However, it does still sport a rather attractive distribution rate at 7.28%. Due to the discount, this comes to 6.92% on a NAV basis. So at least during this current market, this works out to what is a fairly reasonable distribution rate that should continue for the foreseeable future.

Just as the market took a big hit in 2022, so too did BXMX. However, that's where we can see the benefits of the fund's option writing strategy. With that, they generated over $92 million in realized gains. Despite the strong sell-off, they were also successful in generating realized gains from their underlying portfolio. Of course, it was the sizeable unrealized gains that offset all those gains.

Still, options writing gain generation is what can help support the distribution even during a down year. The fund paid out around $98.5 million in distributions for 2022, meaning the options writing premium generated was nearly enough to cover the payout alone. Then the fund also had some positive net investment income to get it over the finish line.

BXMX's distribution tax classifications have changed wildly over the last two years. It could be okay for a taxable account with long-term capital gains and return of capital distributions. However, such drastic changes is one of the reasons why CEFs can be a bad idea for tax-sensitive investors. You just never really can know for sure what the tax classifications will be from year-to-year.

BXMX's Portfolio

The fund looks to invest similarly to the S&P 500 Index. However, they are currently attempting to achieve this through 250 holdings rather than the ~500 in the S&P 500.

In an effort to achieve this, they will, of course, hold the usual suspects or MAMAA, as I like to call them. Or others call them the Magnificent 7 or FAANG names. Those are all generally referring to some sort of combination or variation of Apple ( AAPL ), Microsoft ( MSFT ), Amazon ( AMZN ), Alphabet ( GOOG ) or Meta Platforms ( META ), with the inclusion of NVIDIA ( NVDA ) and Tesla ( TSLA ) when talking the Magnificent 7. These are simply the stocks that have contributed to the vast majority of gains this year

For BXMX, it is particularly important when the fund is writing index options compared to covered calls on individual positions to position itself appropriately. This is because, with index writing, the losses are theoretically unlimited due to not being able to invest directly into the index.

On a side note, this is one of the reasons I was more critical of its sister fund, Nuveen Dow 30 Dynamic Overwrite Fund ( DIAX ). I noted its "odd positioning," where the portfolio doesn't mirror the index it's writing against.

If you are writing index options against the S&P 500, there is SPY that investors have access to. That being said, regardless, when writing against the index will still going to be cash-settled. Therefore, the underlying portfolio of BXMX is a hedge if the index takes off rapidly higher. The losses realized on the options writing can be offset through the realized/unrealized gains from BXMX's underlying portfolio.

Alternatively, if the index stays flat or drops lower, then BXMX collects the premium. That premium offsets some of the declines that the fund would have experienced. This is why a flat market can often be a good environment for a call-writing fund, as it can create gains that wouldn't otherwise be there. In practice, though, markets are constantly moving.

Additionally, when we have a flat market with limited volatility, the options premium received is reduced as premiums available would reflect the lack of movement in the market.

BXMX takes the approach of writing against nearly 100% of the portfolio's notional value and is last listed as having a call option percentage at 99%. The weighted average days to expiration are at 55.11 days. They also write at-the-money options with the average call strike vs. spot price at 100%. This provides the biggest premium received possible, but it doesn't allow for much upside before those gains can quickly turn into losses.

We highlighted above how 2022 was a tough year, but the options writing generated meaningful gains for the fund. Now, let's take a look at 2021's figures . Remember, 2021 was a strong year for the broader market, with the S&P 500 up around 27%.

So what we see below is that the options writing strategy resulted in significant realized losses of almost $117 million. However, the underlying portfolio in unrealized and realized gains significantly outweighed those losses generated and resulted in BXMX having a strong year. Though naturally, not as strong as the S&P 500 Index itself due to these losses being generated.

Conclusion

BXMX is a fund that looks to replicate the S&P 500 and write calls against 100% of its notional value. This is a fairly simple approach and something that isn't revolutionary, as other funds offer this same strategy. However, BXMX also is currently presenting investors with a fairly attractive discount. It isn't a screaming buy by any means. For a long-term income investor looking to dollar-cost average over the longer term, it could still be something to consider here after the overall market has also taken a dip.

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