From the July 2008 issue of Research Magazine • Subscribe!

How to Use Strategic ETFs

Do you remember the first cell phone? The first public cell phone call was made about 35 years ago, in 1973. While the basic concept is still the same, the first cell phone pales in comparison to today's high tech gadgets.

The first U.S. ETF (the S&P 500 SPDRs) was launched in 1993. Unlike the first cell phone, this ETF, albeit simple and straightforward, still remains the most popular ETF around and serves as a benchmark for other ETFs.

We've gotten used to the fact that ETFs allow essentially everyone to invest in equity, fixed income, real estate, commodities, etc. The newest breed of ETFs also offers exposure to sophisticated investment strategies such as the buy/write or 130/30 strategy.

The buy/write or covered call strategy (without going to munch into detail) involves selling call options on securities you already own. The premium received for the call options enhances the overall return. This strategy works well in a flat or down market.

PowerShares and Barclays Global offer a buy/write ETF on the S&P 500. The iPath S&P500 Buy/Write ETF (BWV) outperformed the SPDRs (SPY) by 9.63 percent for the past year. PowerShares just recently launched the PowerShares Nasdaq 100 Buy/Write Portfolio (PQBW).

The 130/30 portfolio strategy has been a very popular strategy for money managers. This strategy uses leverage by shorting poor performing stocks and purchasing shares that are expected to have high returns. The 130/30 ratio implies shorting stocks up to 30 percent of the portfolio value and then using the funds to take a long position in the stocks that are expected to outperform.

First Trust is the first (and so far only) to launch an ETN linked to this strategy. The KEYnotes ETN Linked to the First Trust 130/30 Large Cap Index (JFT) contains a long position of the top scoring 30 percent on an equally weighted basis equal to 130 percent of the value of the index and a short position in the worst scoring 30 percent equal to 30 percent of the value of the index on an equally weighted basis. As with all new ETFs, especially non-market index based, time will be the judge of success.

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