BMO ETF aims to profit from writing puts

Strategy should work well in a rising U.S. market. But beware of bears.

Rudy Luukko 9 September, 2015 | 5:00PM
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BMO ETFs today served up BMO U.S. Put Write (ZPW), an aggressive and unconventional alternative for cash-hungry investors. The exchange-traded fund, which is to make monthly distributions, is aimed at investors seeking a low-correlated complement to their core fixed-income and dividend-paying holdings.

Managed internally by BMO Asset Management Inc., the ETF will sell put options written on roughly 40 U.S. large-cap stocks, but won't hold any of the underlying stocks. Instead, its assets will be held in U.S. Treasury bills or other cash equivalents, thus meeting regulatory requirements for "cash cover" for the options exposure. The U.S. currency exposure won't be hedged.

Mark Raes, head of product for BMO Global Asset Management, told Morningstar that the BMO investment management team is targeting an 8% portfolio yield. This is clearly lofty territory in today's low-interest environment in which, for example, all but the longest-dated Government of Canada bonds are yielding 1.5% or less.

If your first reaction is that the BMO ETF's target return is a risky proposition, you'd be absolutely right. Raes notes that a severe U.S. market correction, such as a 20% decline in the broad market, would result in losses for the BMO ETF as underlying stocks fell below their strike price.

However, the BMO strategy will provide some margin of safety in bear markets. Raes said the options written by the managers will generally be 10% or 15% out of the money. This means the strike price of the option is below the market price of the underlying stock. The option would be a money-loser for the BMO ETF only if the stock fell below the strike price.

BMO U.S. Put Write's strategy will tend to work well when the U.S. market is rising, or at least not falling. The ETF profits from writing a put if, during the option period, the stock price remains greater than or equal to the strike price of the option. Under this scenario, which will be how the ETF makes money, the ETF collects the option premium and the option expires worthless.

Also available in U.S.-dollar-denominated units (ZPW.U), BMO U.S. Put Write will be broadly diversified by security, with fairly equal weights in its puts exposure and no big bets on any one name. The management fee is 0.65% and the projected management-expense ratio (MER) is 0.74%.

Three other BMO ETFs were launched today on the Toronto Stock Exchange. Also managed internally, they are:

BMO Low Volatility International Equity (ZLI), which invests in non-North American stocks that have lower sensitivity to market movements, as measured by their betas. Of the stocks selected for the portfolio, those with lower betas will have higher weightings. This ETF joins two existing BMO low-volatility ETFs investing in Canada and U.S. stocks, respectively. The management fee of the new ETF is 0.40% and the projected MER is 0.45%.

BMO Europe High Dividend Covered Call Hedged to CAD (ZWE), which invests in dividend-paying European companies, writes covered calls on selected stocks to generate premium income, and hedges its foreign-currency exposure. This new offering brings to five the number of BMO ETFs employing covered-call strategies. The management fee is 0.65% (0.74% projected MER).

BMO International Dividend Hedged to CAD (ZDH), which invests in a yield-weighted portfolio of dividend-paying international equities and is a currency-hedged version of BMO International Dividend (ZDI). Stock selection will rely on a rules-based methodology that considers dividend growth, yield and payout ratio. The management fee is 0.40% (0.45% projected MER).

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About Author

Rudy Luukko

Rudy Luukko  Rudy Luukko is a freelance writer who contributes to on topics involving fund industry trends and regulatory issues. He retired in May 2018 from his position as editor, investment and personal finance, at Morningstar Canada, where he had worked since 2004. He has also worked as an editor and writer for various general, specialty and institutional media, and he has co-authored courses for the Canadian Securities Institute. Follow Rudy on Twitter: @RudyLuukko.

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