Covered Call ETFs: A Strategy for Smarter Investing

Covered Call ETFs offer a unique investment strategy that can help you generate additional income from your portfolio. By selling call options on a stock or index you already own, you can collect premiums and potentially reduce your overall cost basis.

The key to success with covered call ETFs lies in choosing the right underlying assets. According to the article, the most popular underlying assets for covered calls are large-cap stocks and indexes, such as the S&P 500.

By selling call options on these assets, you can potentially earn a premium of 1-3% per month, depending on market conditions. This can add up to a significant return over time.

Covered call ETFs can be a great option for investors looking to add some extra income to their portfolio without taking on excessive risk.

Covered call ETFs offer a unique blend of income generation and risk management. They can provide additional income through premiums received from writing call options.

One of the key benefits is the potential to reduce losses in a falling market. The premiums collected from selling call options can act as a buffer against losses.

Covered call ETFs also offer tax benefits. Returns are often taxed at lower capital gains rates, which can enhance after-tax profits.

Here are the main benefits of covered call ETFs:

The benefits of a covered call ETF are numerous, but it's essential to consider the drawbacks as well. A covered call ETF generates additional income through premiums received from writing call options.

One of the main benefits is income generation, which can provide a buffer against losses in a falling market. This is especially true when the premium received from selling call options can reduce losses.

A covered call strategy's gain is capped at the premium received plus any potential upside from the underlying asset up to the strike price. This means you'll never lose more than the premium you received.

These ETFs are inherently safe, with the premiums collected from selling call options providing a buffer against losses. The worst-case scenario is missing out on additional gains if a stock skyrockets.

The performance of a covered call strategy is dependent on the investment manager's selection of call options to be written, which means it's not assured. This is a crucial consideration for investors.

A covered call ETF often produces higher yields than traditional ETFs, making them attractive for income-focused investors. This is because you're benefiting from premium income in addition to potential stock appreciation.

Here are some of the key benefits of a covered call ETF:

Covered call ETFs have been shown to produce higher returns in certain situations. A study commissioned by the Cboe found an 830% return to the at-the-money covered calls strategy between June 30, 1986, and Dec. 31, 2011.

The J.P. Morgan Equity Premium Income fund, a covered-call fund, had a 12-month yield of 10.01% as of Oct. 31, 2023, compared to a 1.56% return of the SPDR S&P 500 fund. This fund outperformed the S&P Index over the same period.

Covered call ETFs tend to perform better in bearish years, when fear and volatility are high, as the large premiums earned from selling covered calls help to reduce losses. The value of covered calls on the S&P 500 goes up when volatility, as measured by the VIX, goes up.

The VIX is also known as the fear index because it tends to rise when the fear of losses is higher. This means that covered call ETFs can be a good option for investors looking to hedge their portfolios during times of high volatility.

The key risks and considerations of covered call ETFs are worth understanding before investing. One major risk is that the gain of the ETF is limited to the premium received for writing the call option, plus any potential upside from the underlying asset up to the strike price of the call options written.

The covered call ETF will also continue to bear the risk of market decline, even if it receives premium from writing the call options. This is because the premium received may not be sufficient to cover the decline in market value of the underlying assets.

There are several factors that can impact the market value of the call options, including supply and demand, interest rates, and the current market price of the underlying assets relative to the call option's strike price. These fluctuations can impact the returns of the ETF.

Here are some specific risks associated with covered call ETFs:

A covered call strategy can be a great way to generate income, but it's not without its risks. One key risk is that the gain is limited to the premium received for writing the call option, plus any potential upside from the underlying asset up to the strike price of the call options written. This means that if the market value of the underlying asset rises above the strike price, the ETF won't benefit from those gains.

Another risk is that the ETF will continue to bear the risk of market decline, even though it receives premium from writing the call options. This is because the premium received may not be sufficient to cover the decline in market value of the underlying assets.

The market value of the call options can fluctuate due to various factors, including supply and demand, interest rates, and the actual or perceived volatility of the underlying assets. This fluctuation can impact the returns of the ETF.

As the ETF needs to write additional call options to maintain its covered call exposure for additional unit creations, there's no guarantee that the identical call options will be available with the same premium or a more favorable premium. This can limit the ETF's ability to generate income.

Here are the key risks associated with a covered call strategy:

A covered call ETF can be a good way to ride out riskier periods in the market while still bringing in a profit.

Partly due to the increase in returns when market volatility is high, a covered call approach is usually considerably less volatile than the market itself.

According to a 2012 and 2019 volatility study by CBOE, the strategy of buying the S&P 500 and writing at-the-money calls had between 30% to 40% less volatility than the S&P 500 itself.

In an unstable political climate, a covered call ETF can help you navigate riskier periods with less volatility.

For example, the Global X Nasdaq 100 Covered Call ETF (QYLD) sells a monthly, at-the-money covered call on the Nasdaq 100, generating income that increases when investors' fears concerning the index rise.

A covered call ETF like QYLD creates income from market volatility, providing at least two benefits: a monthly dividend that increases, and a premium received on the covered-call strategy that serves as a measure of downside protection.

Here's a breakdown of the benefits of a covered call ETF in times of high volatility:

In 2022, when stock and bond indexes fell sharply, the funds outperformed, with JEPI losing only 3.5% and Global X losing only 19%, while the S&P 500 index fell 18% and the Nasdaq 100 index fell 33%.

Covered-call ETFs tend to have higher dividend yields compared to regular ETFs that simply go long on the underlying stocks.

The income generated from selling call options is passed on to fund holders, making it a big attraction for many investors. Most ETFs write monthly call options and pay out the premium they earn at the end of each month.

Covered-call ETFs can include stocks from a range of equity indexes, such as the Russell 2000 and the S&P 500 ESG indexes. Global X offers covered-call strategies that include these indexes.

A fund is essentially a collection of stocks that are managed together to achieve a specific investment goal. Covered-call funds, in particular, own a basket of stocks and sell call options on them.

The fund's performance is influenced by the underlying stocks and the options sold on them. For example, if the stocks rise above the strike price, the fund pays the buyer of the option the difference between the stock price and the strike price.

A covered-call fund can include stocks from various equity indexes, such as the S&P 500 or the Russell 2000. Global X offers covered-call strategies that include the Russell 2000 and the S&P 500 ESG indexes.

The fund earns a premium from selling call options, which is then passed on to fund holders. This premium is typically paid out at the end of each month, making it an attractive feature for many investors.

Here are some key characteristics of a covered-call fund:

Covered-call ETFs offer a lower volatility profile, which can be a major appeal for some investors. They tend to be less affected by market downturns, as seen in 2022 when they outperformed the S&P 500 index.

In that year, the JEPI ETF lost only 3.5%, while the S&P 500 index fell 18%. The Global X ETF lost only 19%, while the Nasdaq 100 index fell 33%. This outperformance led to a significant influx of new money into nontraditional equity funds.

A covered call approach is generally less volatile than the market itself, with studies showing it had between 30% to 40% less volatility than the S&P 500 over a long time frame. This volatility reduction can be a huge benefit for investors, especially during uncertain times.

Jonathan Molchan, a former portfolio manager, notes that a covered call will exhibit less volatility than the broader market. He points to his own ETF, QYLD, as an example, which sells a monthly at-the-money covered call on the Nasdaq 100.

The income generated by QYLD increases when investors' fears rise, creating at least two benefits for investors. Their monthly dividend will increase, and the premium received on the covered-call strategy serves as a measure of downside protection.