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Portfolio Manager Perspectives

Jeff Benjamin

Giving up possible upside but getting more-predictable income

Nov 12, 2012 @ 3:48 pm

By Jeff Benjamin

buy-write, options, equities
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The latest offering from RiverNorth Capital Management LLC will give up some of the market's potential upside in exchange for more-predictable income.

The strategy employed by the RiverNorth Dynamic Buy-Write Fund Ticker:(RNBWX) could be ideal for skittish investors anticipating a period of rising volatility.

The predictable part of the performance, sometimes described as the cushion, comes from the sale of call options on the underlying portfolio of mostly large-cap-growth stocks.

From an investor's perspective, the sale of call options represents an income stream that you can't get merely by owning the stocks.

However, those owners of call options retain the right to purchase stocks from the portfolio at a preset price, which means the portfolio's performance will be capped, ultimately creating a low-volatility alternative strategy.

Eric Metz, manager of the fund, plans to take the basic buy-write model a step further by managing the sale of call options with volatility in mind.

Thus, instead of simply selling new call options when older options expire, Mr. Metz essentially will be playing the volatility, because volatility is a key component that determines the price of a call option.

As Mr. Metz sees it, the underlying securities in the fund, which represent a proxy for broad equity market exposure, are less important than the management of the option sales.

“Traditionally, this strategy just buys the S&P 500 and sells a front-month call on that, but I'm not just turning over the options when they expire,” he said. “The implied volatility moves every day, and we will be managing the portfolio to have the best volatility picture, because the price of the security and volatility don't move in tandem, even though they are correlated.”

RiverNorth, which has $2.3 billion under management, manages three other mutual funds that all invest in closed-end funds, two of which are closed to new investors due to capacity constraints.

The buy-write fund represents the company's first fund that does not invest in closed-end funds.

Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives.

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