Covered Call ETFs Arrive in the Sweet Spot

Covered Call ETFs Arrive in the Sweet Spot

Advisors may take another look at covered call ETFs as investments swing between stagnant and volatile.

Reviewed by: Sean Allocca
Edited by: Ron Day

Double your pleasure, double your fun. That’s the long-time slogan of Doublemint chewing gum and in the investing business, it might apply to a particular type of tasty ETF right now.  

The timing represents a call (pardon the pun) for financial advisors to understand that ETF segment known as “covered call writing.”  

You can find a list of more than 200 covered call ETFs here. The array of styles in the covered calls format has now expanded to where investment advisors need to take notice if they haven’t already. Here’s why: The market climate may be shaping up to put these unique vehicles in their “sweet spot.” And if so, clients are likely to ask about them with increasing frequency. 

Perhaps the best market for this type of ETFs is the one we are in right now, where stocks and bonds gyrate in price over short time frames but not enough to create major trends in either direction. Over long periods in market history, prices of stocks, bonds or both have acted like the NFL running back who evades tacklers, runs 50 yards, but ends up back where he started for no gain of yardage. In other words, for covered call ETFs, nothing (i.e., an extended period of flat returns) can really be something! 

Covered Call ETFs in the Sweet Spot for Advisors

These ETFs deliver steady call option “premium” income, which distinguishes them from regular equity or fixed income investments. That is, a slight gain over time in the price of the underlying investments just adds a bit of return. On the other hand, if those investments drop a little in price, the option premium likely overcomes that, and the ETF produces competitive, positive returns. 

Global X offers several covered call ETFs, the largest of which is the $8 billion Global X NASDAQ Covered Call ETF (QYLD). Its call options are on 100% of the portfolio, expire during the next month, and thus leave little room for upside. But QYLD’s ability to rake in monthly premiums from the volatile Nasdaq 100 limited losses to 19% last year, while gaining 18% so far this year. That compares to the Nasdaq 100’s 33% loss last year and 38% gain this year. As a result, QYLD has outperformed the Invesco QQQ Trust (QQQ) by about 2.5% since the start of 2022. 

Covered call writing ETFs also exist for equity segments beyond the standard market indexes. One is FT Cboe Vest S&P 500 Dividend Aristocrats Target Income ETF (KNG), which has more than $1 billion in assets, and owns and writes covered calls on an index of stocks that have all increased dividend payment for at least 25 years. KNG only writes calls on up to 20% of the value of the stock portfolio, instead of 100% as QYLD and many others do. KNG’s 69-stock ETF portfolio currently spins off a 5% yield, which exceeds its stated dividend target of at least 3% above that of the S&P 500. 

Bonds can be part of this strategy, too. iShares offers a group of covered call ETFs whose underlying investment is a bond market ETF. The one year old iShares High Yield Corporate Bond Buy Write Strategy ETF (HYGW) has $37 million in assets, holds a high yield ETF and writes covered calls on that entire position, out to the next month’s expiration. That has produced an enormous 18.4% yield over the past 12 months, though losses on the underlying bond ETF holding have netted HYGW’s total return to 6.5% over that time.  

Covered calls ETFs are an increasingly popular concept, and ETF issuers have responded by providing a full plate of variations on that approach. That is why investment advisors can now play a critical role in deciphering both the ETF products themselves, and their potential application to each client’s unique objectives. 

Rob Isbitts' Wall Street career spans 5 decades and multiple roles, all dedicated to providing clarity to investors by busting classic myths and providing uncommon perspective. He did so as a fiduciary investment advisor, Chief Investment Officer and fund manager for 27 years before selling his practice in 2020. His efforts now focus exclusively on investment research, education and multimedia. He started ETFYourself and SungardenInvestment to provide straightforward commentary and access to his investment intellectual property for portfolio construction, stocks and ETFs. Originally from New Jersey, Rob and his wife Dana have 3 adult children and have lived in Weston, Florida for more than 25 years.