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TheStreet Open House

'Naked' Writing Produces Sexy Fund Returns

Ronald Egalka does naked writing.

Egalka's careful "writing" (i.e. selling) of "naked" (uncovered by offsetting positions) put options, along with other sophisticated risk-management strategies , have produced steady, positive returns for the closed-end Eaton Vance Risk-Managed Diversified Equity Fund (ETJ) while investors in other funds have been losing their shirts.

While the Standard & Poor's 500 total-return index fell 12.7% during the first seven months of 2008, ETJ's investors enjoyed a market return of 9.5%. Over the most recent three months, the fund marched 3.3% higher, while the S&P sagged 8%.

Because ETJ was initially offered at a premium over its net asset value per share, its NAV return for the past year stands at 8.1%, ahead of its market gain of 4.6%. Both returns are impressive when contrasted with the S&P's fall of 11.1% for the same period.

Egalka, chief executive of option strategy firm Rampart Investment Management, co-manages ETJ along with Eaton Vance veterans Walter Row and Michael Allison. The trio navigates the fund using disciplined risk-management techniques that have kept it on an uphill track during the market turmoil that has prevailed since the fund's debut on July 31, 2007.

The fund's overall stated primary investment objective "is to provide current income and gains, with a secondary objective of capital appreciation." Its largest holdings include mainstays such as Exxon Mobil (XOM), General Electric (GE), Microsoft (MSFT) and International Business Machines (IBM). The research-savvy Eaton Vance analysts and portfolio managers have kept the fund underweighted in the financial sector, which has helped the fund keep its returns from being tarnished by that group's woes.

What primarily sets ETJ apart from the typical long fund is that it has been writing index call options on roughly 67% of its holdings. The premiums received from the sales of the calls provide a steady income stream for the fund. This is a conservative strategy that augments returns but runs a risk of "opportunity losses" during periods of rapidly expanding values -- which haven't been characteristic of the market for some time.

Turmoil in securities markets over the past year has tended to boost the premiums that buyers have been willing to pay for options. This has helped amplify the benefits of ETJ's basic risk-management strategy.

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