ETFs vs Mutual Funds, an additional point
I have already gone into detail why I think ETFs in general make better choices than Mutual Funds. Recently I have come up with an additional point that has a direct financial impact.
Some ETFs are optionable and mutual funds are not. What interests me is not buying options, buy writing covered calls or writing a contract that will give someone the option to buy my stock on or before a certain date at a preset price.
Currently, I am over weighted in international and hold almost no small cap. Adding a Russell 2000 etf position to my portfolio would be a cost effective way to correct that, as would adding a Russell 2000 index fund. But with the etf, I can write covered calls, increasing my return.
Let’s look at an example. To keep the numbers simple but fairly accurate, we will use iShares Russell 2000 Index ETF (IWN) and price it at $80 and we will also say we can sell a May call for $.50, a dollar out of the money.
I buy 100 shares of IWN for $8,000 on May 1, 2006 and immediately write a May 2006 covered call contract with a strike price of $81. The contract is $1 out of the money because the current price of the stock is $80 and the option to buy price is $81, or $1 out of the money. On May 31 or before, my 100 shares of IWN are promised to the contract holder at a price of $81. I was paid $50 (100 x $.50) for the contract. If IWN doesn’t break $81, then it is unlikely that the contract will be executed and I will keep the money and the stock. If it does go above $81, then it is very likely that the contract will be executed and I will end up with $8150 in cash minus fees.
$50 isn’t much right? It actually works out to $41.75 after fees at scottrade. So is it worth the trouble? $41.75/month for a $8000 investment returns over 6%. Definitely something to consider, especially in a down or flat market.