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By Josh Charney, CFA | 01-17-2013 02:00 PM

An Open-End Means to Hedge Volatility

RiverNorth's Eric Metz discusses his firm's reasons to create an open-end buy-write strategy fund and how the portfolio is positioned to mitigate risk.

Josh Charney: Hi, my name is Josh Charney. I'm a fund analyst here at Morningstar. And here with me today I have Eric Metz. He is with the RiverNorth Dynamic Buy-Write fund.

Eric, thank you for joining me today.

Eric Metz: Thank you, Josh.

Charney: So Eric, can you explain to some of our viewers out there what exactly is a buy-write fund?

Metz: Sure. So, a buy-write is by no means new, and it's been around for approximately 20 years. The most visible buy-write in the marketplace today is the CBOE's BXM Index. And what that constitutes of is the S&P 500, and then subsequently than selling a call option on the S&P. But it could just as easily be a single security such as Microsoft in which you own Microsoft and then sell a call option on Microsoft. So, you can either take a buy-write in a single-security form or in an index form.

Charney: So, there are definitely a lot of nuances to all these types of strategies. Can we kind of explain what are some of those nuances?

Metz: Sure. Well, unlike an equity portfolio in which you have a basket of securities in a diversified manner, what a buy-write would do is take that same portfolio and then sell call options and often times in a systematic fashion. There is an expiration and a maturity and a strike price for each option, and so the portfolio manager would then select the maturity and the strike price on each individual security. What that does is it changes the risk/reward profile of that portfolio by mitigating its volatility and potentially enhancing its return.

Charney: So, we kind of looked at where these strategies are in terms of vehicles, and we found that there are 32 buy-write strategies in the closed-end fund world. There are a few exchange-traded funds. There is a just a handful of open-end funds that you know strictly follow this type of strategy. So, why do you think that this strategy is predominantly in the closed-end fund space?

Metz: That's a great question. Coming at RiverNorth, we are predominantly a closed-end fund shop, so we have evaluated the same thing. The reality is that the closed-end fund arena has a fixed pool of assets, and when you're managing an options portfolio because the options portfolio will change the risk/reward profile of your portfolio so dramatically on any given day, managing that portfolio with a fixed pool of money is a much easier task.

We launched an open-end fund, and hence the name Dynamic, because the dynamic nature of the fund will allow us to manage the open-ended form without losing any source of alpha that we see in the marketplace.

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