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Covered Call ETF: A Steady-Earnings Investment Tool

Moomoo Research wrote a column · Apr 7 05:11
In the realm of investing, various strategies resemble secret martial arts manuals from distinct schools, each demonstrating their unique prowess.
Today, we shall delve into one such practical and relatively conservative approach: the Covered Call strategy, along with the financial product built upon it – the ETF that seamlessly executes this strategy at the click of a button.
I. What is the Covered Call Strategy: Dual Insurance with Stocks and Options
Imagine you hold shares in a company called "ABC," having some confidence in its future performance but wary of market fluctuations that might drive the stock price down. In such a scenario, the Covered Call strategy acts as an "insurance policy" for your stocks.
Here's how it works:
1. Owning the Stock: First and foremost, you need to possess ABC's shares. This forms the foundation of the Covered Call strategy since you'll be selling call options against these very shares.
2. Selling Call Options: A call option grants the buyer the right to purchase your shares at a predetermined price (known as the strike price) by a specific future date. As the seller, you receive an upfront fee (called the premium). For instance, if ABC's current stock price is $50, you might sell a one-month call option with a strike price of $55, pocketing a premium of $1.
3. Dual Payoffs: If, after a month, ABC's stock price remains below $55 (not reaching the strike price), the buyer won't exercise the option, and you'll securely earn the $1 premium. Should the stock price rise above $55, the buyer will choose to exercise, causing you to sell your shares at $55. Adding the previously received premium, your effective sale price becomes $56 ($55 + $1). In either case, you've generated a profit.
In summary, the Covered Call strategy involves holding stocks while simultaneously selling corresponding call options, thereby earning premiums to boost your income stream. It's worth noting that you may not desire a rapid stock price surge, as once it surpasses the call's strike price, the buyer can exercise their right to buy your shares at the set execution price, potentially forfeiting your potential gains from a substantial stock price increase.
II. How Covered Call ETFs Generate Returns
Now that we've grasped the Covered Call strategy, let's examine Covered Call ETFs.
An ETF, or Exchange-Traded Fund, is essentially a large basket filled with various assets that investors can buy and sell directly on an exchange, offering convenience and speed.
A Covered Call ETF encapsulates the Covered Call strategy within an ETF product, allowing ordinary investors to reap the benefits of this strategy without directly handling options themselves. How does it accomplish this?
1. Constructing a Stock Portfolio: The fund manager begins by assembling an investment portfolio comprising diverse stocks, such as blue chips, tech stocks, and consumer staples – effectively purchasing "ABC" and other companies' shares on behalf of investors.
2. Regular Sale of Call Options: Subsequently, the fund manager periodically (e.g., monthly or quarterly) sells call options corresponding to the stocks in the portfolio, collecting premiums. These revenues enhance the ETF's overall returns.
3. Easy Investor Participation: As an investor, you simply need to purchase the Covered Call ETF on the exchange, just like any regular stock, to indirectly implement the Covered Call strategy and enjoy dual returns from both stock appreciation and option premiums. Compared to setting up the strategy yourself, this approach is more time-efficient and doesn't require specific options trading qualifications.
III. Covered Call ETF Options and Their Pros and Cons
1. $Global X Nasdaq 100 Covered Call ETF(QYLD.US)$: Focuses on Technology and Growth Stocks
This ETF is based on the NASDAQ 100 Index (QQQ) and employs a Covered Call strategy by regularly selling short-term (typically one month) call options to enhance yields and reduce volatility.
-Pros: QYLD focuses on technology and growth stocks, offering investors the opportunity to implement a Covered Call strategy within the tech sector. This is particularly suitable for investors who are bullish on technology but wish to mitigate volatility; the ETF format simplifies the execution of the strategy.
-Cons: During periods of strong performance in technology stocks, the performance of QYLD may significantly lag behind a pure NASDAQ 100 Index fund that does not employ a Covered Call strategy, as the sold call options may cap gains; it is highly sensitive to specific risks within the technology sector, such as regulatory changes and technological shifts.
Covered Call ETF: A Steady-Earnings Investment Tool
2. $FT Vest S&P 500® Dividend Aristocrats Target Income ETF®(KNG.US)$: Constituents of the S&P 500 Dividend Aristocrats Index
This ETF combines the Covered Call strategy with a dividend growth investment philosophy, investing in constituents of the S&P 500 Dividend Aristocrats Index and selling corresponding call options with the aim of providing a steady income stream.
-Pros: Implements a Covered Call strategy on companies with a solid track record of dividend growth, offering investors dual sources of income from dividends and option premiums, particularly suitable for those seeking long-term stable income; the portfolio contains high-quality, high-dividend blue-chip stocks, adding a level of defensiveness.
-Cons: Since the target index itself focuses on dividend stability rather than capital appreciation, KNG may perform relatively conservatively during bull markets; the strategy relies on the continued ability of the selected stocks to pay dividends, and a reduction or suspension in dividends from constituent stocks could affect overall returns.
Covered Call ETF: A Steady-Earnings Investment Tool
This ETF closely tracks the S&P 500 Index while selling at-the-money or slightly out-of-the-money call options monthly to enhance returns, aiming to provide a higher total return and lower volatility than the index.
Pros: Generates additional income through the sale of options, reducing overall volatility, and offers investors a simplified approach to participate in a Covered Call strategy without the need to directly trade options.
Cons: In bull markets, the sold call options may be exercised, preventing the ETF from fully capturing the index's upward potential; management fees may be relatively high, and the effectiveness of the strategy can be heavily influenced by market conditions, particularly in persistently declining markets.
Covered Call ETF: A Steady-Earnings Investment Tool
4. $JPMorgan Equity Premium Income ETF(JEPI.US)$: Primarily Stocks from the S&P 500 Benchmark
An actively managed ETF issued by JPMorgan, JEPI aims to deliver most of the returns associated with its primary benchmark, the S&P 500 Index, while offering investors reduced volatility and thus lower risk, and still providing incremental income. Normally, the fund invests at least 80% of its assets in stocks and may also invest in other stocks not included in the S&P 500 Index.
-Pros: Offers higher regular distributions than traditional indexes, achieves diversified global stock market investments to reduce the risk of a single region, and is dynamically managed leveraging JPMorgan's expertise in investment research.
-Cons: Returns can be affected by market volatility and the conditions of the options market; relatively higher management fees may reduce net income; the set upper limit of returns from the options strategy may result in missing out on some capital appreciation opportunities during significant stock market rises.
Covered Call ETF: A Steady-Earnings Investment Tool
5. $JPMorgan Nasdaq Equity Premium Income ETF(JEPQ.US)$: Primarily Stocks from the Nasdaq-100 Index
This ETF's portfolio mainly includes equity securities from its primary benchmark, the Nasdaq-100 Index. Unlike traditional technology funds, JEPQ can also allocate up to 20% of its portfolio to equity-linked notes (ELNs) issued by counterparties like banks, which create additional income and can reduce risk to some extent.
-Pros: Integrates elements of technology stocks and offers income generation, while also having lower risk.
-Cons: Compared to passively managed ETFs, actively managed ETFs like JEPQ typically charge higher management fees. Also, due to its substantial holdings in leading technology stocks, the call options it holds might underperform during periods of strong technology stock rallies.
Covered Call ETF: A Steady-Earnings Investment Tool
6. YieldMax Covered Call ETFs:
In addition to ETFs linked to various indices, there are also Covered Call ETFs related to individual companies, such as those issued by YieldMax ETFs, which attract investors with their high dividend yields:
Chart: YieldMax's Corporate ETF products
Source: YieldMax
Source: YieldMax
Among them, the best performer is undoubtedly $YIELDMAX NVDA OPTION INCOME STRATEGY ETF(NVDY.US)$:
Covered Call ETF: A Steady-Earnings Investment Tool
The Covered Call strategy acts like a protective suit for your stocks, obtaining premiums by selling call options. It can protect against the risk of stock price declines to a certain extent while generating additional income.
A Covered Call ETF integrates this strategy into a single product, allowing investors to enjoy the benefits of the strategy without having to personally manage options.
Therefore, for investors seeking stable returns and who are willing to moderately sacrifice some upside potential, Covered Call ETF products undoubtedly provide a convenient option worth considering.
Disclaimer: Moomoo Technologies Inc. is providing this content for information and educational use only. Read more
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