Sure, 5% CDs are appealing. And some bond funds can yield even more than that. But covered-call or "buy-write" ETFs are catching on with investors looking for a unique way to passively score giant yields if the S&P 500 goes nowhere.
Covered call ETFs, such as Global X S&P 500 Covered Call ETF and JPMorgan Equity Premium Income ETF, deliver big 12-month yields of up to 11% with stocks even when the S&P 500 does nothing. And these ETFs shined in August. The S&P 500 went sideways, falling 2.1% during the month. But these ETFs kept churning out income — and their prices rose as well.
"Given the expected market volatility, covered call ETFs can provide equity exposure with some important downside protection and income generation," said Todd Rosenbluth, head of research at Vetta Fi.
How Covered Call ETFs Work
These ETFs own all the stocks in their portfolios outright. But the magic happens as the ETF also sells call options on each of the holdings. This gives the ETF an income stream from the investors who buy the call options.
Owners of covered-call ETFs collect a monthly premium from the buyers of the call options. And they get this income by simply selling the right to buy the shares in the future at a prearranged price, typically set at the time the option was sold. If the stock is flat, the ETF keeps on collecting the premiums from the buyers of the calls. And covered call ETF owners don't have to do anything. The ETF writes the call option contracts on hundreds of positions.
These payouts can add up over time. The Global X S&P 500 Covered Call ETF has paid its investors every month for 10-straight years. This income makes the ETF less risky than a traditional S&P 500 ETF. The Global X S&P 500 Covered Call ETF sports a beta of just 0.54, indicating it's half as volatile as the S&P 500.
Given the risks of chasing after volatile stocks and lackluster performance of S&P 500 dividend-paying stocks, the covered call ETF offers a unique play on a flat market. No wonder investors poured $60 billion into covered-call ETFs since January, says The Economist. That inflow expanded these investments' asset base by 60%.
Choosing Among Covered Call ETFs
Given their popularity, it should come as no surprise that covered call ETFs are rushing to market.
Global X is considered one of the pioneers in the field with a variety of flavors to choose from. Among its most popular are the $2.9 billion in assets Global X S&P 500 Covered Call ETF. It has yielded 8.35% over the past 12 months. But investors looking to amp up their call income might look at Global X Nasdaq 100 Covered Call ETF. It yielded 8.59% over the past 12 months as the call option premiums are higher on more volatile stocks like the ones that dominate the Nasdaq.
But other ETF players are broadening the offerings where active managers pick the stock held in the portfolio, rather than relying on an index. The $29 billion-in-assets JPMorgan Equity Premium Income ETF does just that and has paid 10.4% over the past 12 months.
What's The Risk?
If covered call ETFs are so great, what's the catch? By holding the ETF, you're betting the stock will do nothing. That way, you can keep the stock and keep collecting premiums. If the stock rallies, the owner of the call option has the right to buy the shares at the predetermined (lower) price. And if the underlying stock falls in value, you keep the stock and absorb the loss. And volatile stock prices in the last five years did hurt returns on covered call ETFs. The Global X S&P 500 Covered Call ETF returned 3.84% annually in the past five years, lagging the S&P 500's 10.9% annual return during that period.
But this is exactly the kind of trade-off investors are looking for as the S&P 500 flatlines and interest rates rise.
Popular Covered-Call ETFs
| Company | Symbol | YTD % ch. | 12-month yield | Expense | Assets ($ billions) |
|---|---|---|---|---|---|
| JPMorgan Nasdaq Equity Premium Income | 19.1% | 11.48% | 0.35% | $5 | |
| JPMorgan Equity Premium Income | 1.9 | 10.40 | 0.35 | 29 | |
| Global X NASDAQ 100 Covered Call | 9.6 | 8.59 | 0.60 | 8 | |
| Global X S&P 500 Covered Call | 2.2 | 8.35 | 0.60 | 2.9 | |
| Amplify CWP Enhanced Dividend Income | 0.2 | 3.68 | 0.55 | 2.9 |
