DJIA - Covered Call ETFs And The Limitations Of Stocks

2023-09-21 12:45:00 ET

Summary

• Rob Isbitts explains his perspective on ETFs, describing them as a 3-D investment option with flexibility and a wide range of choices.
• The importance of having a plan for bear markets.
• Investing in covered call ETFs and using offensive and defensive positions to mitigate risk.

Listen below or on the go via Apple Podcasts or Spotify .

Stocks are a 1-dimensional investment world, mutual funds and closed-end funds are 2-dimensional, and ETFs are 3-dimensional, says Rob Isbitts (4:50) who explains how to use option-infused, covered call ETFs (11:25).

Transcript

Rena Sherbill: Rob Isbitts, it's nice to have you on the other side of the mic and great to have you back on Investing Experts. Nice to have you on the show. Thanks for coming on.

Rob Isbitts : Well, thank you very much for inviting me on, Rena. Looking forward to this conversation.

RS : As am I. As am I. You publish under Sungarden Investment Publishing . You also have the Rob Isbitts profile, but share with listeners who maybe haven't heard your earlier episodes with Matthew Tuttle, or maybe even if they have, kind of remind them of where you're coming from in the industry and how your view has been shaped.

RI : Sure. And I’d like to kind of summarize it for the sake of time by just throwing a couple of numbers at you. So the first number is 16. That's the age I was in New Jersey when my late father and my hero, Carl Isbitts, who was never a professional investor, but he was a serious do-it-yourself investor, which immediately attracted me to the nature of Seeking Alpha. We'll get to that later.

37, how many years I've been in the investment business. Started in 1986 out of college. 30 years of that time, I have been in a position to make professional investment decisions. I added up to about 120,000 hours, so I’m no spring chicken, as they say. And I was an advisor, a registered advisor with a client base, high net worth client base, and everything was personalized. And I did that for 27 years, sold that business, “retired” ha-ha, not really. I mean, I'm not the type that's ever going to retire.

And I've been writing for about 25 years. And I said, this would be a great time to pivot kind of second career or semi-retirement career, whatever you want to call it. So after we sold the practice, I started looking for what I’ll call signs of intelligent life, where I can take the knowledge and experience and the writing skills to a bigger audience, but without providing personalized advice because I'm out of that business.

And yeah, so a little over a year ago, this company called Seeking Alpha contacted me and they said, what about contributing with us as an analyst? And the rest as they say is history and what I have enjoyed most about the past year.

By the way, tomorrow – we're recording this on Wednesday, I guess. Tomorrow is my one year anniversary of my first post on Seeking Alpha. So I'm very happy about that, and I thank everybody there. But I've received and answered more than a thousand comments over the past year. I try to answer every single one.

And it's really helped shape not just where my mind should go in the continuing evolution of these kind of modern markets , as I call them, but it's also given me a sense of what investors and mass are thinking about.

And that's been a great back and forth and I look forward to that continuing because it's getting down to brass tacks, as they say, in terms of the stock and the bond markets. And so good time for this conversation.

RS : I want to get into ETFs with you. Not many people are covering ETFs , not many people are covering them in in-depth like you are. So I'm curious for those investors searching out the ETF universe, how would you synthesize and quantify how you look at the ETF space?

RI : Sure. That's mostly what I write about other than strategy pieces. So let me try to boil it down this way. I think it's always better if you can kind of put things in perspective of what you already know.

I would think of it this way. Stocks are kind of like a one-dimensional investment world, mutual funds and closed-end funds are two-dimensional, and ETFs are three-dimensional. And I don't mean actual, like the physics definition of dimensions, okay?

Stocks are one-dimensional, here's why: because no matter what happens in a bad market, your great companies can get dragged down with everything else. And, steal my thunder a little bit for 30 seconds from now probably, the equity market, I should say the ETF market, is such that it has made everything more indexable.

And so as a result, if you take, I don't know, pick a FAANG stock, okay, and we've seen this, you may love a particular FAANG stock. But if money gets flying out of the NASDAQ and the Qs, okay, which have billions and billions of dollars in them now, the ( QQQ ) ETF, which is the NASDAQ 100, well, guess what?

There's so much selling pressure that has nothing to do with that one FAANG stock that you own and love. It's too much of a headwind and your stock price is not going to go up. That to me has always been the limitation of individual stocks. You can't hedge them and increasingly, they are guilt by association, even if the companies are solid and you spend years trying to find a stock that sells at actual fair value.

And so anyway, I'm not discouraging anybody from that. I'm just saying it's what caused me to move on from that early in my career and not do nearly as much stock investing.

So the two-dimensional world, mutual funds and closed-end funds. A lot of categories, you can even profit from falling markets. I mean, I've managed three mutual funds during my career. I learned a lot about mutual funds, ETFs, and value of hedging when I started running my first fund on August 14, 2008. It seems like a history quiz today.

August 14, 2008, the S&P was already down 15% in the next seven months. All it did was fall another 55%. Welcome to managing a mutual fund, kid. And so I learned a lot about risk management, then didn't lose nearly as much, but I said, I'm not going to let that happen again.

And so what ETFs do versus this kind of one and two-dimensional world? Yeah, they have some structural advantages that relate to taxes, but I'm not a tax advisor. So I'll focus on the other aspects and how I use them.

I believe they're on their way, if they’re not already there, to having the widest range of investment choices available. There's over 3,000 ETFs. And really, to me, the best thing about them is that you can use them to slice and dice in segment and subsegment and micro segment, just about any market.

You can hedge your investments and I write a lot about that and you don't need to use leverage. I mean, there are levered ETFs, but you don't have to go that way. You don't have to take out a margin loan to effectively have a short position. And so to me, the flexibility is key number one.

Number two, and this is a misperception, which I've had a lot of discussions with in the comments section with Seeking Alpha readers. ETFs are actually quite liquid in most cases, because it doesn't matter even if it's a small kind of hidden gem, which I read a lot about kind of hidden gem ETFs, the undiscovered, you can have an ETF that has a very low asset base and doesn't trade that much.

But if what it owns, the underlying investments are very simplified, let's say you and I started an ETF and all it does is it buys the Dow, the Dow 30, it's 30 liquid stocks. That thing could go probably two weeks without a single trade being executed and they have very little in assets.

But if the ETF company has set up trading arrangements where they have market makers that are willing to buy or sell a basket of the 30 Dow stocks in this case. As soon as a trade order comes in, problem solved. They're as liquid as just about anything.

So I don't want anybody to be sort of frightened off of ETFs saying, well, it doesn't have enough assets, et cetera. I see that a lot in the comments and I've responded to people. But since we're talking to a lot of folks here, I wanted to make sure.

The other thing about ETFs that I love - they're an excellent, excellent way to track market trends. I maintain a list of about 150 myself, although I'm at least conversant in over 3,000. So that I think that qualifies me to be an ETF geek. Would that not?

RS : I think so, yeah.

RI : Okay.

RS : I think that's the classic definition. Yeah.

RI : Yep. My parents would have been proud. So the – I mean, again, I have kind of a dashboard. I've shared bits and pieces of this. I think I probably will share some more with the Seeking Alpha audience going forward.

But whether it's like, if you want to know what the market's doing, don't just look at the S&P and the NASDAQ, look underneath. And there's an ETF. It's kind of like there's an app for that. There's an ETF for that.

There's an ETF for all the broad market equity stuff, sectors, industries, themes, segments of the bond market, segments of the commodity market, individual commodities, I mentioned you can invest in oil. You can invest in oil with covered call writing on it. You can invest in oil through the stocks. You can invest in oil through the big integrated oil companies. You can invest in oil through the drillers, okay? You can invest in oil through the global companies. I mean, there's so many ways to slice it up.

RS : How do you use the covered calls with ETFs? How do you implement that?

RI : Yeah. So I was hoping we would get to this because if there's anything that to me is, let's call it, trending right now in the work I'm doing for Seeking Alpha, there has been a dramatic increase in issuance in ETFs that are what I would call option-infused.

A lot of those are covered call ETFs, where they simply take something that individual investors and their brokers, going back to when everyone was a broker, not an advisor, I mean for decades people have been saying, okay, I own stock XYZ. It's selling at $50. If I'm willing to give up the upside in the next three months above $55, because I don't think it’ll go up 10%, I can get paid now.

And so you receive that covered call income, and you can continue to do this over and over and over again over time. And it had, for a lot of people I see in the Seeking Alpha audience, especially in this era of such low rates on cash and safer bond alternatives, the interest came up.

And then, of course, there were a couple of funds that got very, very big. I now count over 200 ETFs out of maybe 3,500 in issuance that are actually option oriented. A lot of them are completely off the radar. So guess what mister hidden gem ETF guy, me, is going to be doing a lot more work on them. I already have, but I'll be doing a lot more.

And so what that allows people to do is to perhaps have some upside. They're all a little bit different. Some give you very little upside, and it's all about capturing that premium income from the covered calls, some go part of the way, some are really equity funds, but have a little bit of a sliver of hedge.

Where I have come to the Seeking Alpha audience, and this is as current as like since the beginning of September I think, I wrote a couple of articles that were very well received. And what I really loved about them is that the comments section turned into like a mini course, not taught by me, but moderated by me, because people were asking great questions. A lot of people have experience with this, either through ETFs or they were doing this with stocks for a long time and it's a high caliber audience here.

So, I looked at it and I said, okay, maybe covered call ETFs where you give up a lot of the upside, but you still get a nice total return in good markets because you're bringing in that premium income, that's great. And they're especially great for sort of trading range, stagnant, volatile, but goes nowhere ultimately markets, which is what we had in stocks and maybe we'll have in bonds. And there are covered call ETFs for bonds and some commodities too now. But there's one problem, bear markets.

So when the stock market falls precipitously, that covered call income only gets you so far. And the best example, and I think this is how markets are going to work more going forward than they have in the past because of like everybody is an investor and it’s global and 24/7 and I mean, I don't have to tell you, given the environment we're in Seeking Alpha, there's always new information.

And because of that, markets are likely to be more volatile. And even when it comes to bear markets, it's kind of like very gradually and then all at once. And when that happens, like in February, March of 2020, you're getting that covered call income typically every month, maybe every quarter. But then you see – so it's covering you a little bit at a time. You're making a 0.5%, 1% a month in covered call income.

Well, if the underlying stock portfolio that you're getting those option premiums on falls 20% in a month, even 10% in a month, you just go way behind. And I think it's going to be a lot harder for markets to bounce back from big defeats going forward because we've already come so far and it shows in valuations and things like that and the bond market alternative, all the other stuff I've talked about before.

So I guess the bottom line on covered call ETFs and really what the nature of these two articles is about is, okay, what I write about is what I do for my own money because I'm not in a personalized advice business anymore and what somebody else does with the information obviously is up to them.

But I can tell you that my own portfolio, other than a huge slug of T-bills , because of the reasons I mentioned earlier, okay, the other income part that I have for my family is a lot of covered call ETFs, but it's an array of them. I own typically three to five at a time. I'm looking at different markets and I actually analyze them in terms of which ones is the best value.

RS : Can you say the three to five that you're looking at right now, just for context?

RI : Yeah, sure. So currently, I own ( DJIA ), which is the Dow, based on the Dow and writes covered calls on the Dow. I own ( XYLD ), which is the S&P version . I own ( QYLD ), which is the NASDAQ version. Those are Global X products, but it’s not a commercial for them.

And the biggest position I own right now is ( TLTW ), which takes the 20- to 30-year treasury, very popular ETF, writes covered calls on it. And then I also have a smaller position, which I started recently in ( USIO ), which is the oil price or ETF that tracks the oil price, with covered call writing on that.

Now, the T-bills are a bigger part of the portfolio than this, but I think they're going to swap places when T-bills aren't yielding 5%, okay. But as much income as I'm bringing in, because I figured if my baseline, if I've got a lot of money that's bringing in 5%-ish, okay, and I can target maybe double that, maybe even a little bit more with these, that's great.

But again, one problem, big market declines, okay, or since options are driven by volatility, the VIX volatility indicator is as low as it's been in a long time and frankly, right where it was before 2022 started and we had an awful market. So any type of repeat of that, stock prices are going to fall.

And if that happens, what do you do? I think the standard response to people that own covered call ETFs is to say, ah, it'll all wash out over time. And that works until it doesn't. And remember, I was an advisor to retired and approaching retirement people for 27 years until I sold the practice and exited that business three years ago. And so I've been through those conversations for three decades. I mean, more than I can count.

And I can tell you that the perceived safety of going into covered call ETFs without a plan for bad markets is going to leave a lot of people disappointed and frankly feeling, to use an old expression, hoodwinked. Like, I can't believe people wrote about this. So what I did in these two articles and I will continue to do it in some more coming up is, say, you know the covered call ETF position is more like a core. It's an anchor in your portfolio.

But as an example, okay, XYLD is the S&P 500. What if the S&P falls really hard? Well, there's plenty of ETFs that you can take a small or a big position in, up to you, but they exist to offset what happens when things don't go well for XYLD.

And the flip side of that is, well, at some point we'll get a really bad market. What will happen after that? We'll get a really good market. And when that happens, maybe you won't need the hedge so much. You still will want that covered call income, okay, and you'll be getting more of it because volatility will probably be up and that gives you more option premium.

And so, I mean, look, everybody knows what ( SPY ) is. If you own an XYLD, okay, and you say, I like the covered call thing, but the problem is I get capped out. I can't – if the market goes up 20%, I'm just getting my covered call premium. Well, you can tactically add an offensive position by owning - whatever SPY is an example, but any equity ETF.

So at the end of the day, most people are looking at covered call ETFs as one holding. And I'm looking at it as one - in my portfolio - as one core holding which I tactically add offense and defense around it.

So hopefully that brings it all together because I think I'm very happy that in the last month, I feel like I've been able to maybe move the conversation a bit forward on Seeking Alpha about covered call ETFs and option-infused ETFs, but more importantly, about the whole concept of what I call playing offense and defense at the same time.

RS : I think with the popularity of ( JEPI ) and the discourse around these ETFs , I think it's really important to get some context and really explain to investors, I think, the advantages of using this. So I think that this has been great. And I also would say to people listening, share your questions and comments with us.

And hopefully, this is an ongoing conversation. I think this is a conversation that we can keep furthering people's education and interest in the space and how they can best use this to profit through an unstable and unsure market. So I appreciate it. And hopefully, this is just the first of many conversations that we dig deeper into this.

Happy for you to share with, I know you have some new things going on in Substack in addition to all your encouraging missives from Seeking Alpha. If you want to share with listeners all the many different places they can find you. And maybe if you want to share with listeners, what else they can look forward to in your writing at Seeking Alpha and the conversations here.

RI : Sure. Thank you for giving me that opportunity. We actually have a brand-new website. It really is my personal research deck come to life. You know what we decided to call it?

RS : What's that?

RI : ETF Yourself. Okay. I have to be careful the way I emphasize that. It's ETF Yourself, how to use ETFs to invest yourself.

RS : I like it.

RI : Part of it was inspired by answering a thousand comments in the Seeking Alpha audience. So what's in there? All the market indicators and research techniques I've developed and refined over the decades, the stuff I used to manage my own money, my model portfolios, ETF research, I cover 150 of them that I'm familiar with 3,000 of them, risk ratings.

I built something based on my charting experience, which is a technical rating, but it's not so much about where can I make a – a killing in the next month, it's where is the risk? Because as I said before, anything can make money in any time. We'll have model portfolios in there, running commentary on what I think about the markets.

If you will, I think, it probably goes hand in hand with a lot of the topics and a lot of the, let's call it, evidence and research that I have and will be presenting on Seeking Alpha. So kind of an outgrowth.

And so ETF Yourself , Substack, is this really neat platform we put it on, very interactive as well. The company is Sungarden Investment Publishing or SIP as we call it. And we always invite people to take a SIP of what we're doing on Seeking Alpha, the profile page, and I'm on LinkedIn and Twitter. So that's Rob Isbitts and gang.

RS : Awesome. Rob, appreciate it. Rob Isbitts, Sungarden Investment Publishing, Go ETF Yourself, no just kidding. ETF Yourself…

RI : You said it, not me.

RS : All right, Rob, I appreciate you. Talk to you soon. Thanks for sharing so much information with us.

RI: Thanks a lot.

RS: Thank you.

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