Are Covered Call Funds a Smart Income Play?

Portfolio diversification

What’s better? A covered call options strategy executed by the individual investor or a covered call ETF or fund that proposes to do the heavy lifting?

Selling covered calls is a popular investment technique used by investors with high income or cash flow as their primary goal.

The investor is “covered” because they own the underlying security or ETF inside their portfolio. And by selling a covered call, the investor collects premium income from the sale and effectively caps any potential gains in the underlying security at the strike price of the call option sold.

Covered Call ETPs
In the ETP market (which includes both ETFs and ETNs), products that use the covered call strategy are typically focused on one asset class or category.

For example, the PowerShares S&P 500 BuyWrite Portfolio (NYSEARCA:PBP) is tied to the CBOE S&P 500 BuyWrite Index. The fund sells a succession of written options, each with an exercise price at or above the prevailing price level of the S&P 500 (NYSEARCA:IVV). Dividends paid on the stocks underlying the S&P 500 and the dollar value of option premiums received from written options are automatically reinvested. PBP’s annual expense ratio is 0.75% and it carries a yield near 6.74%.

Another example, of a covered call ETP focused on a single investment category is the Credit Suisse Gold Shares Covered Call ETN (NYSEARCA:GLDI).

GLDI sells approximately 3% out-of-the-money notional calls each month while maintaining a notional long position in the SPDR Gold Shares (NYSEARCA:GLD). The notional net premiums received, if any, for selling the calls are paid out at the end of each monthly period.

Although GLDI carried a yield of 12.32% from its inception date on 1/28/13 through the end of last year, the note tumbled 31.14% because of big declines in gold. GLDI has around $22 million in assets and charges annual fees of 0.65%.

Covered Call Chart Feb 2014

Covered Calls on a Basket of ETFs
My preferred high income strategy is selling monthly covered calls on a basket of low cost ETFs versus owning covered call funds concentrated on one asset class. With the first strategy, the investor controls the length of the trade and the amount of income they generate. The investor also has the ability to capture dividend income on the underlying ETFs, which boosts income levels even further.

Our Income Mix ETF Portfolio at ETFguide sells monthly covered calls on a basket of low cost ETFs. From Dec. 2012 to Dec. 2013, it generated $9,825 based upon a $100,000 hypothetical all-ETF portfolio linked to stocks, gold, and real estate.

Are there any reasons for favoring a covered call fund versus selling covered calls on your own?

If the investor has limited assets and can’t own at least 100 shares of an ETF or stock to sell covered calls on, a covered call fund might be a better alternative.

Also, if you don’t feel comfortable executing the covered calls yourself or you’re too busy, a covered call ETF or fund may possibly make sense. But understand you’re not going to get the same results you could obtain selling covered calls on your own.

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  1. smarder11 says:

    How does one sell CC on a basket of low cost ETF’s as alluded to in this article? I would love to do this

    • Mike says:

      Selling covered calls on an ETF is the same as on a stock. One particular issue with ETFs is that you want to make sure that they have sufficient trading volume where an option chain will exist. If you have never sold calls before, you will likely need to get approved by your brokerage firm to show that you will not “blow up” your account with options trading. Generally, to begin trading options you have to have experience trading options. Sounds like a catch-22? Follow the price of the option trades on paper to see how the price movements occur then put that down as trading experience. Any of the major brokerage firms like Schwab or Fidelity will have a specific team that can explain to you how to trade options. Be very specific that you want to sell a covered call. This is a less risky strategy vs the alternatives, if they ask what you are trying to accomplish be able to explain that you are trying to generate income.

      One caveat to what the author wrote: Generally you need to have 100 shares of an ETF or stock to sell a call. Recently they have come out with what are called “mini options” for expensive stocks, so that you can trade only 10 shares. These are not available on all stocks.

      Also, in general you will get the best premiums by selling options (covered calls) with a 1-2 month expiration. You can sell longer term options, 6 months or 2-years, which saves you the extra work every few months but lowers your annualized rate of return. Good luck!

  2. jim McBroom says:

    Have been trading options for 35+ years, but lately have been trading the “weeklys”. My broker worries that commissions are slowly chewing me up, but I like the flexibility they afford. Still, I’m considering 2 or 3 weeks before expiration. Your thoughts ?
    Thank you.

    • Ronald Delegge says:

      Calls with weekly expirations have become quite popular and the trading volume can be robust, depending on the ETF ticker. However, because the weekly time frame is more compressed vs. monthly you’re likely to bag less income…plus your strike price will need to be much closer to ETF’s trading range at the time you execute the trade. If you can trade weeklys (2) times per month and get more income after factoring in trading commissions vs. (1) time with monthly call options you’re coming out ahead. But you need to do the math.

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