What Is an Option Income Fund?

An option income fund, also known as an option income closed-end fund (OI-CEF), is a type of pooled investment whose goal is to generate current income for its investors by earning premiums from selling options contracts.

Option income can be generated by selling 澳洲幸运5官方开奖结果体彩网:delta-neutral options strategies such as 澳洲幸运5官方开奖结果体彩网:straddles or 澳洲幸运5官方开奖结果体彩网:strangles, by writing 澳洲幸运5官方开奖结果体彩网:covered calls, or utilizing other more complex strategies.

Understanding Option Income Funds

Option income funds are usually best suited for tax-advantaged accounts because the profits those investors earn on the options sold are then taxed as ordinary income, rather than as divi👍dends.

One way these funds generate income is to sell options strategies that are delta-neutral, meaning that they do not change in value as the market moves either up or down. A short straddle is an options strategy comprised of selling both a 澳洲幸运5官方开奖结果体彩网:call option and a 澳洲幸运5官方开奖结果体彩网:put option with the same strike price and 澳洲幸运5官方开奖结果体彩网:expiration date.

A strangle is similar, but uses calls and puts at different strike prices instead. It is used when the trader believes the underlying asset will not move significantly higher or lower over the lives of the options contracts. The maximum profit is the amount of premium&nbs🎃p;collected by writing the options. The potential loss, however, can be unlimited if the market moves significantly, ღso it is typically a strategy for more advanced traders.

A covered call is another common strategy. It includes selling a call option on a stock that is currently being held in the portfolio. When using a covered call strategy, the portfolio can still lose money if the underlying asset falls in price, and the maximum profit to the upside is also limited. If the asset's price stays relatively flat, however, a covered call strategy can be a relatively low-risk income generator.

Option income funds offe൲r clear rewards, including higher returns than standard funds. But such an income-generating strategy can also be much riskier than simply investing in divi💖dend-paying stocks. Because they utilize options contracts, there are several more risk factors.

That's why option income CEFs have both proponents and naysayers. For an example of the latter, see a 2005 Bloomberg article titled "Option Income Funds: Watch Out," which argues that while payouts may be generous in low-yield times, their risks are great.

The Benefits of Option Income Funds

On the other hand, a 2012 piece in Kiplinger opined that "Option-Income CEFs May Be a Smarter Choice."

Jeffrey R. Kosnett has written that there are roughly 30 option-income CEFs, and they include everything from funds that focus on just the 30 stocks in the Dow Jones industrials, to funds that sell options on emerging-markets stocks. He explained that there are some key advantages to such funds: "Whatever their strategy, option-income CEFs share two virtues. First, all trade at discounts to their net asset value per share. Second, these funds are ideal for a market stuck in a fairly narrow trading range."

The reason, according to Kosnett, has to do with covered-call strategies: "A call option gives its holder the right to buy, or call, a stock from the option's seller at a certain price by a certain date. Buying options is risky. But selling a call against a stock you own is a conservative strategy. By doing so, you limit the potential appreciation of your stocks, but you generate additional income through the sale of the options."

Kosnett further noted the following:

Option-income funds designate much of their distributions as a "return of capital," a phrase that suggests you're not getting a true dividend. But just as there is good cholesterol and bad cholesterol, there are good and bad returns of capital. Cash inflows from option sales are repeatable and sustainable.