Are Covered Call ETFs a Safe Investment Choice

Covered call ETFs can be a safe investment choice for conservative investors who want to generate regular income. They work by selling call options on a underlying asset, such as stocks, to collect premiums.

This strategy can provide a relatively stable source of income, but it's essential to understand the risks involved. Covered call ETFs can limit the potential upside of the underlying asset.

Investors should also consider the potential for missed opportunities, as selling call options means giving up the possibility of capital gains if the asset price surges.

For another approach, see: Global X Covered Call Etf

Covered call ETFs can be a safe investment option for conservative investors, as they typically involve selling a call option on a small portion of the underlying assets, reducing potential losses.

These ETFs usually have a low to moderate risk profile, with a maximum potential loss of the initial investment.

Investors who sell call options on their ETF holdings can earn income from the premiums received, which can help offset potential losses from market fluctuations.

However, the income generated from selling call options is generally lower than the potential gains from the underlying assets.

Some covered call ETFs are designed to provide a stable source of income, often with a focus on dividend-paying stocks, which can help reduce volatility.

Investors should carefully review the underlying assets and the ETF's investment strategy to ensure it aligns with their risk tolerance and investment goals.

When implementing a covered call ETF strategy, it's essential to consider the trade-off between income generation and potential losses. Covered call ETFs can provide regular income through option premiums, but this comes with a risk of assignment, where the underlying shares are sold at the strike price, potentially resulting in losses if the stock price falls below the strike price.

To mitigate this risk, investors can use a strategy known as "rolling", where they sell calls with a higher strike price to limit potential losses. This approach can help maintain a consistent income stream while reducing the risk of assignment.

By understanding the mechanics of covered call ETFs and implementing a well-thought-out strategy, investors can potentially generate regular income while minimizing losses.

You might like: Rotors Covered

An active and flexible covered call strategy can be a game-changer for investors looking for steady cash flow in a high-interest-rate environment. Core inflation may have abated, but Canadians are still feeling the pinch, making it a great time to consider this approach.

Some portfolio managers use an active and flexible covered call option writing strategy to achieve this. They follow a key dynamic that involves a trade-off between income generation and market growth opportunity.

Writing options on a higher percentage of the portfolio means it's less exposed to market growth, but it allows the ETF to generate consistently high monthly distributions. In fact, some ETFs cap call option sales at 33% of holdings, while others can utilize the full 100% limit rate.

This flexibility is crucial for investors who want to maximize their returns. For example, Harvest ETFs' fixed income ETF suite can utilize up to 100% covered call writing to generate a higher yield and maximize monthly cash flow.

Investors can choose from different strategies, such as playing long duration and pursuing higher monthly cash flow with expected higher volatility, or seeking exposure to a "happy medium" of high monthly cash distribution with expected lower volatility.

Discover more: Jp Morgan Active Etfs

A win-win situation in investment strategy means both parties benefit, but it's not always easy to achieve. This concept is closely related to the concept of synergy, where the whole is greater than the sum of its parts.

Investors can benefit from a win-win situation by diversifying their portfolios and reducing risk. By investing in assets that are not correlated with each other, investors can minimize potential losses.

Diversification can also lead to increased returns, as seen in the example of investing in a mix of stocks and bonds, which can provide a steady income stream and potential long-term growth.

In a win-win situation, both parties must be willing to compromise and work together to achieve a mutually beneficial outcome. This requires effective communication and a willingness to listen to each other's needs and concerns.

Investors who prioritize long-term growth over short-term gains are more likely to achieve a win-win situation. By focusing on the bigger picture, they can make more informed investment decisions that benefit both themselves and their partners.

Additional reading: Best Etfs for Growth and Dividends

Options can be a powerful tool in your investment strategy, giving you the right to buy or sell a specific amount of an underlying security at a set price.

A call option is a contract that gives you the right to buy a security at a specific price within a specific time period, typically bought when you believe the security will increase in price.

You don't necessarily need to own the underlying asset to buy a call option, but you do need to consider whether you're buying a "naked" option, where you don't own the security, or a "covered" option, where you already own the security.

The call seller makes money upfront by collecting a premium, which they can keep regardless of the security's price movement.

If the security price stays flat or declines, the option contract expires and the call seller makes money from the option premium.

Expand your knowledge: Why Is It Called Fiat Money

An ETF can be a good investment, but it's essential to understand its potential drawbacks.

Some ETFs pay a high income yield, which can be attractive to investors. However, this yield may not be sustainable in the long run.

Investors may be drawn to ETFs because they offer diversification and can be traded throughout the day.

But, as seen with covered call ETFs, their appeal may be limited to specific situations.

A unique perspective: Invesco Kbw High Dividend Yield Financial Etf

Covered call ETFs can be a great way to generate steady cash flow, but it's essential to consider the trade-offs. Using up to 100% covered call writing can increase yields, but it also means the ETF is less exposed to market growth.

The risk rating of covered call ETFs can vary, with some having a low to medium risk level. For example, the Harvest Premium Yield Treasury ETF (HPYT:TSX) has a low to medium risk rating.

To manage risk, some ETF manufacturers, such as Harvest, cap call option sales at a percentage of holdings. In Harvest's equity-income based ETFs, they cap call option sales at 33% of holdings, while in their fixed income ETFs, they can utilize the full 100% limit rate.

You might enjoy: Vaneck Semiconductor Etf Holdings

The NEOS S&P 500 High Income ETF (SPYI) aims to yield 10% to 12% with an average option contract duration of six to seven weeks.

It's essential to understand that covered call strategies can reduce or defer taxation through the use of Section 1256 contracts and active portfolio tax management.

The one-year return for the NEOS S&P 500 High Income ETF is 23%, compared to the S&P 500's 36.4%.

Some investors may be wary of the trade-off between income generation and market growth opportunity with covered call strategies.

Writing options on a higher percentage of the portfolio means it is less exposed to market growth, but allows the ETF to generate consistently high monthly distributions.

It's worth noting that the Harvest Premium Yield Treasury ETF (HPYT:TSX) uses up to 100% covered call writing to generate a higher yield and maximize monthly cash flow.

The risk rating for HPYT is low to medium, and it sits on the long end of the maturity spectrum.

You might enjoy: What Is Vanguard S&p 500 Etf

The Harvest Premium Yield 7-10 Year Treasury ETF (HPYM:TSX) also uses up to 100% covered call writing to generate higher cash flow, with a risk rating of low to medium.

It's situated in the middle of the maturity spectrum, offering a "happy medium" of high monthly cash distribution with expected lower volatility.

Higher fees compared to passive ETFs can significantly impact your investment returns. A 0.60% expense ratio, like that of XYLD, is 20 times more than the 0.03% expense ratio of VOO.

The extra cost of active management is a crucial consideration. This is especially true for long-term investments where small differences in fees can add up over time.

VOO's low expense ratio is a big advantage for investors. It means you get to keep more of your returns, which can add up to a significant amount over the years.

Higher fees can eat into your investment returns, making it harder to achieve your financial goals. This is a key trade-off to consider when choosing between active and passive ETFs.

Consider reading: Low Expense Ratio Etfs

Covered call ETFs are an underperforming long-term strategy. They can't deliver better returns in a market that keeps going up, and selling the upside gain on an underlying security means you'll miss out on gains.

The distribution yield doesn't equal investment return. It's a common misconception that a high-income yield means a high investment return.

In the case of Cuban and Yahoo's shares, if the stock price goes up to $150, you'll miss out on a $55 gain while only receiving a $4 premium. This $4 premium looks like a 4.2% yield, but it's not a good trade-off.

If Cuban wanted to keep the strategy going, he'd have to repurchase the stock at $150, realizing $51 of lost appreciation. This is what the calculation looks like: $95 initial share + $4 income – $150 to reset the position = -$51.

XLYD, which performs a covered call strategy on the S&P 500, underperforms Vanguard's S&P 500 ETF (VOO) by more than 50% in the past five years. This gap gets wider as you look on a longer time horizon.

Over the long run, stocks tend to go up, and covered call strategies involve selling the upside gain on an underlying security. This means you'll be losing out on gains if the security keeps going up.

You might enjoy: Leveraged Etf Strategy

You can never completely eliminate risk when trading options, and covered calls are no exception. Even with a solid research-backed strategy, surprises can still occur.

Surprises are always possible, no matter how much research you do. You can't predict with certainty how the stock price will move.

If your covered call option is at the money (ATM) or in the money (ITM), your stock could be called away from you. This is because the option holder has the right to buy the stock at the strike price.

The deeper your option is ITM during the lifetime of the option, the higher the probability that your stock will be called away and sold at the strike price.

Recommended read: Covered Call Gold Etf

Selling covered calls can increase yield, and it's a strategy used by some ETFs to boost distribution yields. They sell covered calls, collect the premiums, and distribute part of the premiums to shareholders.

The premiums from selling covered calls can add up to a significant amount, especially if you're selling multiple options. For example, if you sell a call option and the stock price is below the strike price, you get to keep the premium.

Covered calls tend to perform better in flat or down markets because the call options typically won't get exercised. This means you'll get to keep the premium and your shares, resulting in a higher yield.

However, in hot or volatile markets, covered calls can lead to poor performance, as the call options may get exercised and you'll have to sell your shares at the strike price. This can be a loss if the market price is higher than the strike price.

The key is to understand the risks and rewards of selling covered calls, and to use this strategy in a way that aligns with your investment goals and risk tolerance.

On a similar theme: Leveraged Emerging Markets Etf

The Westwood Salient Enhanced Midstream Income ETF (MDST) is a great example of a covered call ETF that's doing well. It has an energy infrastructure portfolio with an options overlay that benefits from a hot midstream-energy sector, with average dividend yields of 5% to 6%.

The fund distributes exactly $0.225 per share each month, which currently equates to an annual yield of 10.4%. This predictability is a key advantage of this ETF.

Greg Reid, a comanager of the fund, says they write monthly calls on each of the roughly 25 U.S. and Canadian stocks and master limited partnerships (MLPs) in the portfolio.

A fresh viewpoint: Spdr Portfolio Etfs

The Neos S&P 500 High Income ETF is a unique fund that holds all the stocks in the large-company index and sells call options on the index, maintaining an average option contract duration of six to seven weeks.

This strategy allows the fund to generate a yield of 10% to 12%, with the current yield at 11.7%. The fund's one-year return is 23%, which is impressive compared to the S&P 500's 36.4% return during the same period.

The fund's use of Section 1256 contracts and active portfolio tax management also helps to reduce or defer taxation, which is a significant advantage for investors.

The Westwood Midstream Income ETF is a great option for investors seeking predictable dividend income. It distributes exactly $0.225 per share each month, which currently equates to an annual yield of 10.4%.

This ETF's energy infrastructure portfolio benefits from a hot midstream-energy sector, with average dividend yields of 5% to 6%.

Suggestion: Are Dividend Etfs Worth It

Covered call ETFs can be a safe investment option for those looking to generate regular income, as they typically involve selling call options on a basket of stocks, which can help to reduce the overall risk.

The key to success with covered call ETFs is to choose a fund with a low volatility index, such as the S&P 500, which has historically had lower price swings compared to other indices.

Regular income is a major benefit of covered call ETFs, with many funds offering monthly or quarterly distributions to investors.

These distributions can be an attractive feature for investors who need a steady stream of income, such as retirees or those living on a fixed income.

The fees associated with covered call ETFs are generally lower than those of actively managed mutual funds, which can help to save investors money over time.

In fact, many covered call ETFs have expense ratios of less than 0.5%, which is significantly lower than the average expense ratio of actively managed mutual funds.

Recommended read: Exchange Traded Mutual Funds Etfs