Thesis
The Eaton Vance Tax-Managed Buy-Write Opportunities Fund (NYSE:ETV) is one of our core holdings, and we covered the name last about a year ago with a ‘Hold’ rating:
2023 was a difficult year for the fund due to its structure, with the name lagging the S&P 500 performance given the covered calls tenor set-up, and the sudden increases in equity prices rather than a smooth ride up.
In this article we are going to revisit the name in light of the 2024 macro picture, and highlight why we believe the name is an appropriate fund to utilize in order to obtain equity exposure and extract dividends.
Back to having a similar performance to the S&P 500
This year has been a much better one for the fund, with the smooth market ‘grind-up’ being closely matched by the CEF:
Year to date, the CEF is up 9.4% on a total return basis, while the S&P 500 is up 11.7%. Buy-write CEFs do best when the market moves up in a smooth fashion, with small weekly gains. In this layout the CEF obtains most of its benefit from its written call options, and is thus able to closely match the S&P 500 performance.
ETV, just like the other buy-write names, will still be negatively affected by the very low VIX environment currently prevailing, macro set-up which results in lower than normal option premiums to be had.
The Discount to NAV is historically wide
ETV usually trades at a slight premium to NAV of 5% on average:
Due to its poor performance in 2023, the market has now moved the name to a very large -7% discount to net asset value. If we look closely at the above chart we will notice this discount is a historic wide one, when we remove the Covid shock in 2020.
It seems market participants are now pricing in for every year to resemble 2023, which is not the case in reality. Buy-write funds tend to do poorly in violently upswinging markets, because their overlay feature greatly reduces the upside. Not every year will see the same exponential up-move, and we believe there will be a mean-reversion in the discount to NAV, with the potential for a 7% gain as the fund trades flat to its net asset value.
Classic buy-write construct
As per its literature:
The Fund invests in a diversified portfolio of common stocks and writes call options on one or more U.S. indices on a substantial portion of the value of its common stock portfolio to seek to generate current earnings from the option premium. The Fund’s portfolio managers use the adviser’s and sub-adviser’s internal research and proprietary modeling techniques in making investment decisions.
The CEF has only 169 holdings, and its top names are as follows:
The portfolio managers try to outperform the index on the back of their holdings selection. The fund will generally never hold all the 500 components of the S&P 500, but will always engage in individual name selection as driven by its portfolio managers.
The covered calls are overlaid on 96% of the fund holdings, with a very short tenor:
The average days to expiration for the options is 17 days, and they are only slightly out of the money at 0.4%. This translates into the CEF having a 2-week roll period (roughly) for its options, and an upside which is very much capped at 0.4% during that period.
The fund does best when the index increases by less than 0.4% during every rolling 2-weeks (options have a better chance of monetization in this scenario), and does the worst versus the index when the S&P 500 records large gains in a short amount of time.
The portfolio managers have flexibility in terms of options chosen, but they focus on rough 2-week tenors for the CEF, all while they do adjust the ‘moneyness’ of the options:
The above is from our last article in 2023, and we can see that while the average tenor was still around 2 weeks at 15 days, the “% Out of the Money” has changed from 2.5% to 0.4%. This change makes the fund even more sensitive to upswings in stock prices.
Active management plays a large role in the success of many CEFs, and ETV has demonstrated throughout the years its ability to adjust its options delta on the best risk/reward call cohort.
Main risk factors
1. Hard Landing
The largest risk factor for a fund like ETV is a ‘hard landing’ scenario in the wider equities markets. The fund is closely correlated to the SPY on the downside given the low protection provided by the written calls. The call option overlay mainly serves as a method of extracting premiums and paying the fund’s dividend, rather than a tool to manage the downside for the fund.
2. A permanent volatility shift
One of the issues in the past two years for many buy-write funds has been the shift lower in volatility:
A low VIX level translates into lower option premiums, all else equal. One of the market thought processes is that the introduction of ‘0DTE’s options is to blame for the shift lower:
After the listing of ‘0DTE’s for every business day in 2022, the volume exploded as per the above graph courtesy of Bank of America. ‘0DTE’s are now close to 50% of all option volume in the market.
While 2023 has seen a very subdued volatility, we are yet to see if long term this is a permanent shift, or just a temporary one. We have not had a significant VIX spike since 2022, and given the current volumes for ‘0DTE’s and related products it will be interesting to see how they will be affected when volatility does indeed spike.
Conclusion
ETV is an equities buy-write CEF. The fund comes from the Eaton Vance family, and has a very robust track-record in transforming equity returns into dividends. The fund was negatively affected by the low VIX environment in 2023 and the exponential upswing in equities, factors which hampered its performance and caused the fund to swing to a discount to NAV.
2024 has seen a ‘grind-up’ in equity returns, set-up which has helped ETV closely track the S&P 500 performance. Outside any unforeseen negative shocks, ETV will continue to perform in 2024, with the macro set-up favoring a continual slow rise in equities with long periods of range bound action. This macro picture is favorable for ETV, which should subsequently see its large -7% discount to NAV close-out. We hold the name and find the CEF attractive in today’s environment versus an outright SPY buy.
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