PBP: Heads You Lose, Tails You Don’t Win

The markets seem to be digging deeper into quicksand. The S&P 500 (SPY) has just joined the Nasdaq 100 (QQQ) and the Russell 2000 (IWM) in correction territory. Treasuries (TLT) have already been there since January 2021, while gold (GLD) remains in a stubborn drawdown that began in mid-2020 — see chart below.

In the current environment, it is hard to choose a good investment. Will macroeconomic and geopolitical tensions ease, benefiting growth stocks, for example? Or will the scenario deteriorate, benefitting conservative assets like commodities and, maybe, bonds?

Picking the probable winners might not be simple, but I find it easier to single out the likely losers. Among them is the Invesco S&P 500 BuyWrite ETF (PBP). In this article, I explain why this ETF will probably underperform in the foreseeable future.

What is PBP?

The Invesco S&P 500 BuyWrite ETF is what is also known as a covered call fund. That is: an ETF that (1) invests 90% or more in the components of the broad stock market index and (2) holds a short position in S&P 500 call options. By writing calls, the fund collects the premium associated with them and, in exchange, gives up upside potential in case the index rises.

The fund’s investment in the S&P 500 components is straightforward. Currently, PBP allocates 7.3% of its assets to Apple (AAPL), 6.0% to Microsoft (MSFT), and so on. The option writing piece is a bit more complex. The methodology is explained by the CBOE:

The SPX call written will have about one month remaining to expiration, with an exercise price just above the prevailing index level (i.e., slightly out of the money). The SPX call is held until expiration and cash settled, at which time a new one-month, near-the-money call is written.

Why PBP will likely disappoint

Why would an investor want to buy shares of PBP? The most obvious answer, to me, is income. Since the fund sells calls every month, it raises cash via option premium that it can then use to pay investors.

However, PBP has historically been a low yielding ETF, maybe due to the management company’s decision to be conservative on distributions. In fact, over the past three years, PBP has yielded less than a plain S&P 500 ETF and much less than a high-quality dividend payer ETF (QDIV) — see chart below.

The second possible reason is partial downside protection. Because PBP writes calls, it can use the premium earned to offset some of the capital losses, in case of stock market weakness.

However, keep in mind that PBP does not actively protect its assets against market downturns. Since it holds a long position in the S&P 500’s underlying stocks, the ETF fully participates in any potential downside in the equity index.

The drawdown graph below is telling. Notice how PBP dipped almost as much as the S&P 500 during the bear markets of 2008-2009 and 2020; and the quasi-bear of late 2018.

What PBP certainly does not offer is any more upside exposure than the S&P 500 already does. Because of the short call position that caps the gains, an eventual spike in stocks (especially if it happens fairly quickly) is unlikely to fully translate into capital appreciation for PBP.

This, for example, is what happened after the bottom of the COVID-19 bear. Notice below how PBP fully participated in the selloff; but then, it failed to keep up with the S&P 500 during the recovery.

Between a rock and a hard place

The scenarios laid out above help to explain why PBP is stuck in a game of “heads you lose, tails you don’t win”. A stock market meltdown will probably result in PBP sinking as well, whereas a recovery should disproportionately benefit a plain-vanilla S&P 500 ETF.

The only case in which PBP may outperform and please investors is if stocks move largely sideways going forward: not too far down to hurt PBP’s underlying stock portfolio, not so far up that the gains are capped by the ETF’s short call position.

Looking to bet on the stock market simply dragging its feet from here? Sure, maybe PBP is for you. But otherwise, I think that this fund falls under the “likely loser” column. I would not own PBP in most market environments, less so in the current one.