Gold ETFs Meet Covered Calls In Brand New Gold ETN (GLDI, GLD, BWV, PBP)

gold standardEric Dutram: Gold investing has seen a very rocky road over the past few months. The metal was poised to once again beat out the S&P 500 in 2012, but an extremely weak end to the year put a stop to that.

Now that we are well into 2013, the trend hasn’t been much better for gold bugs, with the precious metal falling by the wayside. In fact, gold has underperformed by about 500 basis points so far this year, signaling to many that the bear market for gold may be continuing.

This could be especially true if investors continue to embrace dividend products as a substitute for gold as a safe haven play. These dividend stocks and ETFs have been stealing gold’s thunder for some time as gold is notorious for its inability to pay out dividends which forces a focus on capital appreciation, something that has been minimal at best in recent months (read Gold ETFs: Is the Sell-Off Overdone?).

However, this trend could be changing thanks to a new Exchange-Traded Product from Credit Suisse. The company just released the Gold Shares Covered Call ETN (NYSEARCA:GLDI) which could be the combination of stability and yield that many investors have been waiting for in the gold market.

GLDI in Focus

This new ETN is linked to the return of the Credit Suisse NASDAQ Gold FLOWS 103 Index. This benchmark looks to utilize a covered call investment strategy on a notional investment in the SPDR Gold Trust ETF (NYSEARCA:GLD).

Basically, the product will hold a notional long position in GLD while it will simultaneously notionally sell out of the money call options on the position on a monthly basis. With this process, any premiums received over the notional trading costs are paid out to investors.

The process is done by holding a notional position in GLD and then selecting the strike price roughly 40 days from expiration, usually focusing in on calls that are 3% out of the money. These are then sold over the next five days while the cash received for selling the calls is held in the portfolio.

After that, GLD is sold notionally to buy back the calls over a period of about five days. Then, roughly a week before expiration, investors are paid out net cash as a monthly distribution before the process starts all over again (see Invest Like Morgan Stanley with These 5 Commodity ETFs).

The process is somewhat complicated but Credit Suisse has a handy chart of the process, which we have taken from their fact sheet and reproduced below:

It should also be noted that the product will charge investors 65 basis points a year. This is a level that is significantly higher than what we see in pure-gold products like GLD or IAU, but obviously the type of exposure in GLDI is much more complex.

The yield should help to offset this though, as the product is expected to make a monthly distribution thanks to the covered call strategy. Currently, Credit Suisse has seen a 9.45% annual yield over the past year, with a big variability from month to month thanks to the shifting returns inherent in the covered call market.

Investors should also remember that this product is structured as an ETN as opposed to an ETF. While this isn’t a big deal, it does mean that the product will not actually hold GLD or the covered calls—hence the constant talk of ‘notional’ investments—but it will not have tracking error either (see ETFs vs. ETNs: What’s The Difference?).

Can It Succeed?

Many have not embraced this style of exchange-traded investing as of yet, thanks to some credit risk from the underlying institution (in this case UBS), which has scared off some investors. However, this is a minor worry, and it makes somewhat difficult or illiquid strategies more investor-friendly overall.

So if investors can get by this credit issue and focus in on the yield, GLDI could be an intriguing, and undoubtedly novel, choice. It is one of the only exchange-traded ways that investors can provide their portfolios with some measure of income in the gold space, though it could cap gains if gold takes off in short-time periods.

Still, it will be interesting to see if this method catches on with investors and if inflows follow for GLDI. There are only two other covered call products out there right now—(NYSEARCA:BWV) and (NYSEARCA:PBP)—and these target the broad market, so it is hard to say how successful Credit Suisse’s ETN will be (also see AdvisorShares Files for Innovative Option-Based ETF).

If GLDI can produce nearly double digit yields in the future, as it has in the trailing one year, it could be an interesting precious metal play. This could be particularly true for investors who like the safe haven properties of gold, but have been put off by its lack of current income, at least until now.

“Gold is often criticized as a portfolio investment because of its lack of any yield,” said Greg King, head of exchange traded products in Credit Suisse’s Investment Bank in a press release. “Covered call strategies however, are designed to enhance yield in exchange for sacrificing part of the upside of an investment position. GLDI seeks to provide investors and their advisors an interesting new way to introduce monthly cash flows into their portfolios.”

This article is brought to you courtesy of Eric Dutram From Zacks.

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