Covered call is a strategy of going long on underlying securities while selling call options on the same security. Covered call writing or buy-write strategy is an investment strategy in which an investor buys some stocks or just a stock and also writes covered call options on those stocks providing a premium income in equity portfolio. These premiums help in offsetting losses when markets are bad or falling. Covered call ETFs utilizes this strategy to varying degrees to limit losses at the expense of limitations on appreciation in the value of a fund.
Covered call strategy can produce incomes that delineate the incomes on bonds and dividend stocks. However where covered call ETFs work well in the long term but not in times when there is a global crisis in the economy. When markets fall hard and then rebound fast an investor can end with an ETF that may fall little less than the stocks it hold and also lags significantly on the upside.
Covered call ETFs are advised to be used with caution and in an appropriate way by financial experts. There are two indexes that are linked to the covered call ETFs including S&P 500 and NASDAQ. There are currently following popular covered call ETFs in the market.
- Advent/Claymore Enhanced Growth & Income (LCM)
- Enhanced S&P 500 Covered Call Fund (BEO)
- Dow 30 Premium & Dividend Income (DPD)
- First Trust/Fiduciary Asset Management Covered Call Fund (FFA)
- Madison/Claymore Covered Call Fund (MCN)
- S&P 500 Covered Call Fund Inc (BEP)
- S&P 500 BuyWrite Portfolio ETF (PBP)
- BMO Covered Call Canadian Banks ETF (ZWB)
The covered call strategy for ETFs is a conservative one with increasing appropriateness for investors as they grow older. Buy-write strategies do offer attraction for the investors since it can lessen the overall volatility in a portfolio. There are examples when some buy-write strategies for ETFs significantly outperformed stocks in the year 200 when stock prices fell.
It is important to understand the performance of the covered call ETFs. They tend to outperform when the market is declining and underperform when the prices are soaring. Covered call ETFs also pay a robust dividend yield related to the underlying long positions and the premiums received from writing call options. The standard to evaluate the returns of covered call ETFs is generally the S&P 500 BuyWrite Index.
Covered call ETFs also requires more active management than basic index tracking ETFs so they charge a higher management fee. They can also benefit from more favorable tax treatments in case of non registered accounts. Experts suggest that they should be included with the stocks in a portfolio instead of bonds. The weightings for covered call ETFs can go higher in percentages from the rest of the stocks in a portfolio. Basically these are good options for investors with high knowledge scale on fund investments. There are many brokerage firms that do not even offer the service of covered call ETFs because of the complexity involved.
