The Buy Write Strategy uses Blue Chip Shares to generate regular monthly income
According to the ASX, it’s the most widely used and basic options strategy and is widely regarded as conservative because it decreases the risk of share ownership.*
In its simplest explanation, the Buy Write strategy involves buying a share or equity and writing a call option over that share to generate a premium or income. In the case of the Accelerator Fund, each month the fund manager will buy a parcel of shares, typically from the Top 20 ASX listed companies. The Top 20 shares offer the greatest liquidity, and tend to be more stable and less prone to volatility compared to smaller companies.
The fund manager then writes Call Options over the parcel of shares. A Call Option gives the buyer of the Option, the right but not the obligation to buy the fund manager’s shares between now and a specified date in the future at a pre-agreed price.
For this right to purchase the shares at a pre-agreed price (called the strike price), the person who buys the Call Option from the fund manager will pay a premium to them. Depending on market conditions and sentiment this premium can vary. In typical market conditions the premium for an option with a month until expiry generally averages up to between 1% and 2% per month. At times of peak volatility as in the last few years, premiums of 5-7% per month have not been unusual. However, in ‘normal’ market conditions up to between 1-2% is generally considered an average range.
Income from the Buy Write Strategy is linked to volatility
Option premium is affected by volatility – volatility means how quickly share prices are moving up and/or down in a short period. In principle, the higher the volatility of a share or the market in general (ie the more it moves in a day), the higher the premium paid.
Conversely, premium goes down if volatility is lower. This is why the income distribution can vary from month to month. The investment manager attempts to balance the portfolio to smooth returns, but it is inevitably impacted by volatility.
Interestingly, one of the potential benefits of the strategy can be seen in a falling market. Generally volatility rises as markets fall, which means that often options premiums go up. In other words, the investor is paid more.
This increase in income can significantly decrease or neutralise a decrease in capital value and is one of the main reasons the Buy Write Strategy has the potential to outperform conventional investing in the share market.
It stands to reason if you are getting increased income during times of market uncertainty, your capital will potentially go down less (or not at all) and could recover more quickly.
A little more detail about the Buy Write Strategy and Call Options
Options are traded over lots of 1,000 shares. Meaning each Call Option an investor sells is representative of 1,000 underlying shares. One Call Option would give the buyer the right to purchase 1,000 shares at a pre-agreed price (strike price) on or before a certain date in the future. If you’re trading five Call Options, that’s the equivalent of 5,000 shares etc.
Options are generally bought and sold at specific strike prices. For shares under $2, strike prices are at 10 cent intervals. $1.00, $1.10, $1.20 etc. For shares $2 – $10, intervals are 25 cents- $4.50, $4.75, $5.00. Above $10, strike prices are at 50 cent intervals.
Options generally expire on the Thursday before the last trading Friday of the month. The exception to this rule can be when the last Friday of the month is a Public Holiday such as Christmas Day, Good Friday. If this is the case, the expiry will take place on the Thursday a week earlier.
A hypothetical example illustrates the Buy-Write Strategy
At the end of the December an investor buys 1,000 BHP shares at a price of $45.65. Wanting to generate an income for the month, the investor decides to write a Call Option over their BHP shares.
The investor writes January $46.00 Call Option and receives a premium of $1.04 per share. As the investor wrote 1 Call Option and 1 Option covers 1,000 shares the investor received $1,040 worth of premium, $1.04 x 1,000 shares.
For writing the call option the investor is then obligated to sell their 1,000 BHP shares at $46.00 anytime between selling the option and its expiry (the Thursday before the last trading Friday of January) if the buyer of the Option chooses to exercise their right. The premium the buyer paid for the Option at the start of the month is what gives them this right. Even if the shares rise in price to more than $46.00 the owner of the option still can purchase them from the investor at $46.00.
In this hypothetical example, at expiry one of three things will occur:
BHP share price is above $46.00:
The owner of the option will almost certainly elect to exercise their option and purchase the shares from the investor at the pre-agreed price of $46.00. The investor will keep the $1,040 premium they received at the start of the month and also receive a capital gain of $0.35 per share. The result of originally buying their shares at $45.65 and then selling them at $46.00
BHP share price is at $46.00:
The owner of the option may or may not elect to exercise their option. If they do, the same scenario above applies. If the owner elects not to exercise the option the investor keeps their 1,000 BHP shares. Regardless of whether or not the option is exercised, the investor keeps the $1,040 of received premium.
BHP closes under $46.00
The owner of the option virtually certain to choose to not exercise and will allow the option to expire worthless. The investor keeps their 1,000 BHP shares as well as the $1,040 of received premium.
In all possible scenarios the investor retains the premium received for writing the Call Option. This is what forms the income component of the Buy-Write strategy.
At expiry, if the investor still owns the BHP shares they can choose to Write a February Call Option and generate further premium income.
If the January option was exercised and the investor had to sell the 1,000 BHP shares they can choose to purchase a new parcel of shares (BHP or any other share they decide upon) and write a February Call Option and generate further premium income.
It is this regular monthly Call Writing the Buy-Write strategy employs that allows the investor to generate a regular monthly cash income. Regardless of the shares price moving up, down or remaining flat the investor keeps the premium.
The benefits of the Buy-Write Strategy are:
No Leverage- the Buy-Write does not require leverage or borrowings to perform
No Interest Payments – with no leverage or borrowings there are no interest payments, allowing the monthly premiums to be reinvested or used towards funding a lifestyle
No negative gearing – with no leverage, borrowing or interest payments, negative gearing is not a factor.
Lower Risk – according to research published by the ASX* the Buy-Write is a lower risk strategy than the Buy and Hold Investment strategy. Generating monthly premiums can help to offset any decrease in share prices.
Liquidity – As the Buy-Write typically is carried out using options with a four week expiry, investment capital is only committed one month at a time. And in the case of an emergency need for funds an investor can choose to buy back the Call Option to negate their obligation to sell their shares a pre-agreed price. Depending on the share price and time to expiry this may be at a greater price than the original premium.
Strong Cash Flow – With the ability to Write Call Options each month, a regular monthly income stream is available to an investor committed to the Buy-Write Strategy.
The Potential Downsides of the Accelerator Fund
There are always risks in investing. There are three important risks with the fund:
1. In a fast rising market the returns may be less than the market – In order to generate the increased income the fund earns it has a capped upside each month. What this means is that if the market goes up significantly in any single month or in a series of months the fund may possibly not benefit from all those gains. The good news is that over the long term this does not happen very often so in most other market conditions the strategy of the fund has the opportunity to outperform the market.
2. The fund will probably fall if the market falls – The Fund invests in the share market so it is not immune to rises and falls. The good news is that it only invests in blue chip shares so to a certain degree this helps and importantly the income the fund receives means that falls can be less than the market. Indeed in some conditions the fund can even go up when the market goes down. The Buy-Write strategy the fund uses is no riskier than owning a portfolio of blue chips shares (and is in fact less risky, according to the ASX Buy Write Facts Sheet* AND it offers increased cash flow).
Most investors have Blue Chips in their portfolio even if it’s just in their Super Fund. So why not put Blue Chips to work earning an income? And remember, that additional income puts an investor in a better position and lowers their risk overall.
3. The capital value of the fund may sometimes go down after the distribution is paid – Income is earned at the end of every month and distributions are paid at the beginning of every month. Because the fund is biased to income the unit price of the fund (its capital value) may fall after the distribution is paid. The Buy-Write strategy uses its income to outperform the market in the long term. By taking all the income the investor may experience a degrading of their capital over time. This can be remedied by reinvesting some or all of the distributions of the fund if you wish.
To fully understand the returns and risks associated with the fund please refer to the Accelerator Product Disclosure Statement (PDS).
Accelerator Fund
Accelerator is a professionally managed fund that actively employs the Buy-Write strategy. It is an excellent option for investors who are seeking to profit from the Buy-Write strategy yet do not have the time to trade the strategy or the capital to ensure a well diversified portfolio. Learn more about the Accelerator Fund today.
* ASX Buy Write Fact Sheet
"Strategy summary: While this strategy can offer limited protection from a decline in price of the underlying share and limited profit participation with an increase in share price, it generates income because the investor keeps the premium received from writing the call. At the same time, the investor enjoys the benefits of underlying share ownership, such as dividends and voting rights, unless they are assigned an exercise notice on the written call and are obligated to sell the shares. The Buy Write is widely regarded as a conservative strategy because it decreases the risk of share ownership."
Important Information
The Excela Australian Equity Income Accelerator Fund aims to produce in excess of 1% per month (or 12%p.a.) on average in premium income distributions.
A realistic expectation of income distributions from the Fund could be up to between 0.8% - 1.5% per month on average.
The capital value of the Fund can rise and fall with changes in market conditions and sentiment. Payments of distributions can have a negative effect on the unit price of the Fund.
Percentage monthly income distribution figures were calculated using the distribution amount against the average balance of the fund for that month.
The fund does not guarantee any particular return or that distributions will be paid monthly (however it aims to do so).
Investments can go up and down. Past performance is not necessarily indicative of future performance. To fully understand the potential returns and risks associated with the investment please refer to the PDS.
For the current performance of the Accelerator Fund please go to Historical Performance.
This information has been prepared without taking into account your investment objectives, financial situation, or needs. Before making an investment decision you should consider the appropriateness of the information having regard to these matters. Before you invest it is important that you read and understand the terms set out in the Accelerator™ Product Disclosure Statement ("PDS"). In particular, it is important that you understand the risks associated with an investment in Accelerator™ set out in the PDS.
Fundhost Limited ABN 69 092 517 087 AFSL 233 045 ("Fundhost") as the Responsible Entity is the issuer of the Excela Australian Equity Income Accelerator Fund ("Accelerator™") ARSN 139 641 946. Excela Funds Management Pty Limited ABN 25 124 028 244 ("Excela") is the Investment Manager for Accelerator™. Excela is a Corporate Authorised Representative of Excela Equities Limited ABN 17 010763041 which is the holder of an Australian Financial Services Licence (246510) and a Market Participant of the Australian Securities Exchange ("ASX").
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