How to use covered call and buy-write strategies to generate income while understanding the risks and having realistic return expectations.
Topics covered include:
- How covered call strategies work
- How much can you earn investing in covered call strategies
- What are some numerical examples based on current option prices
- How covered call strategies can be used for both stock and bond ETFs
- What are some covered call ETF examples
Show Notes
Investments Mentioned
JP Morgan Equity Premium Income ETF (JEPI)
JP Morgan Equity Premium Income Fund (JEPIX)
Global X NASDAQ 100 Covered Call ETF (QYLD)
Global X S&P 500® Covered Call ETF (XYLD)
iShares 20+ Year Trs Bd Buywrt Stgy ETF (TLTW)
WisdomTree PutWrite Strategy Fund (PUTW)
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Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 471. It’s titled “Unlocking Income: A Comprehensive Guide to Covered Call ETFs.”
Two weeks ago, in episode 467 I mentioned that the largest actively-managed ETF in the US is the JP Morgan Equity Premium Income ETF. It has over $30 billion in assets, and it took in close to $13 billion just in 2023. Alone. This ETF invests in a strategy known as covered calls. It’s also known as a BuyWrite strategy. There is a similar ETF, the Global X NASDAQ 100 Covered Call ETF (QYLD). It has over $8 billion in assets under management. A similar strategy to JEPI, the JP Morgan Equity Premium Income ETF.
I’ve recently had a member of Money for the Rest of Us Plus, our premium membership community, post in the forum about strategies like this, where in this member’s view the returns are potentially 12%, because that’s the yield on the Global X NASDAQ 100 Covered Call ETF (QYLD). Now, there’s a difference between the yield and the actual return. If we look at the 10-year annualized return for QYLD, it’s been 7.2% annualized. And over the past three years, it’s returned 5%, despite the very high yield. It lost 19% in 2020.
And this member was looking at these high-yielding ETFs and was asking “Well, why not invest in them if they could earn 12% to 15% per year with little downside?” It seems like a great investment. Now, if we could find investments with little downside, that could earn 12% to 15% annualized, that would be a beautiful environment.
But unfortunately, it doesn’t exist. Perhaps for a short period of time, but 10 years annualized double-digit returns with little downside risk don’t exist. But covered call strategies can be an attractive addition to our portfolios. So in this episode, we want to look at what is a covered call strategy. How does it work? What are the risks? Under what circumstances do they do well, and when will they do poorly?
How Covered Call Strategies Work
A diversified covered call investment strategy, like we’re going to talk about today, are also known as BuyWrite strategies. It consists of two steps.
One, we buy an investment; that could be an individual stock, a basket of stocks that comprise an index, such as the stocks that make up the S&P 500. The investment could be an ETF that tracks an index such as the S&P 500. Or the investment could be a bond ETF, and we’ll look at some covered call strategy ETFs where the underlying investment is bonds. That’s step one, buying an investment.
Step two is sell a call option on the underlying investment. Selling a call option is also known as writing a call option, and that’s why the strategy is sometimes called BuyWrite. We buy the investment, and then we write a call option.
When we sell a call option, we receive premium income. Just like an insurance company that underwrites an insurance policy; they receive a premium in return for paying out a claim if something happens, if someone’s car is stolen, or a house burns down. A call option is similar. The seller acts like an insurance company, in terms of they receive premium income, and then they pay a claim if something specific happens.
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