As broader markets such as the and have given up some of their recent gains, market participants are looking for stable returns. One of those niche areas that has been gaining increasing interest: covered call ETFs.
Here we will go into the covered call space and introduce a fund worth considering:
Dynamics Of Call Options
Although we define different options strategies With call and put options beyond the scope of this article, it would be essential to appreciate the basics of a call option. In this post, we'll take a look at stocks and index options.
A "call option" or "call" is a contract between the buyer (owner) and seller (writer) of an option. It gives the owner the right to buy a stock – or another underlying asset – at a specified price for a fixed period of time specified in the options contract.
Options are only valid for a specified period of time, so the buyer has the right, but not the obligation, to purchase (or & # 39; remove) an agreed amount of an underlying stock at the option writer's strike price. calling & # 39;) until the expiration date.
Individual stock options can have different expiration dates. The most common is the monthly expiration date on the third Friday of a given month, but many have weekly options that expire every Friday. The further the date passes in time, the more an option is usually worth. Unlike index options, individual stock options can be exercised before they expire.
Buyers of options must pay a specified amount of & # 39; premium & # 39; pay to option writers, so sellers are typically motivated by this premium or income.
What is a covered call?
An option contract typically represents 100 shares of a given stock. If the writer owns all or part of the underlying asset (has a long position), the call option becomes a & # 39; covered call & # 39; mentioned. a covered call strategy, an investor must own 100 shares for each call contract he / she plans to sell.
When the investor buys 100 shares of a stock at the same time and writes a call option against that stock position, this is known as a "buy-write" transaction.
When an investor writes a covered call, that investor sells someone else the right to buy 100 shares of the shares that the investor already owns, at a specific price, within a specific time frame.
In other words, a covered call is a hedged strategy, as the writer is able to deliver the stock when called.
NASDAQ 100 Covered Call ETF
Current price: $ 21.25
52 week range: $ 17.22 – 24.18
Yield within 30 days per second: 0.28%
Distribution return (12 months trailing): 11.38%
Net Expense Ratio: 0.60% per year, or $ 60 with a $ 10,000 investment
The NASDAQ 100 Covered Call ETF (NASDAQ 🙂 follows a " covered call" or " buy-write" strategy, taking all stocks in the, one previously mated. QYLD “ writes” or “ sells” monthly at-the-money index call options.
Individual stock options and index options have several differences, which are emphasized by the management of the fund. Unlike some stock options that can be exercised at any time, index options cannot be called / exercised early. They are also cash-settled, not as delivery of the underlying index positions.
Since index options cannot be called early, the place where the index ends in the month is most important to an investor. Any price fluctuations that may occur during the month are irrelevant.
QYLD, which includes 104 companies, tracks the index . The top ten holdings comprise approximately 58% of the total net assets, which amount to approximately $ 1.3 billion. The top five companies are Apple (NASDAQ :), Amazon.com (NASDAQ :), Microsoft (NASDAQ :), Facebook (NASDAQ :), and Alphabet (NASDAQ :), (NASDAQ :).
Year-to-date, the NASDAQ 100 Index and Invesco QQQ Trust (NASDAQ 🙂 are up more than 30% and 33%, respectively.
However, QYLD, which invests in the same securities as QQQ but then sells covered call options on all of its holdings, YTD is down about 8%.
QYLD & # 39; s 12-month distribution yield is 11.38% and this is the return an investor would typically have received if he had owned the fund during that period. The fund pays monthly. When an ETF, such as QYLD, sells a call option, it collects a premium from the option buyer. Thanks to these premiums, the fund can distribute extra income.
At the end of the month, QYLD tries to distribute some of the income from writing / selling the NDX index option to the ETF shareholders and repeats this process at the beginning of each new month.
The premium thus provides income in sideways markets and offers limited protection in falling markets.
Investors should note, however, that covered calls limit an ETF's profit in a rising market. For example, while the NASDAQ 100 index is up about 41.32% over the past 12 months, QYLD investors saw a return of 11.38% over that period.
The calls made each month have by definition limited returns. With covered call ETFs, in exchange for receiving the premium, investors later give up potential upside, a fact highlighted in the fund's prospectus. QYLD has given up earnings potential in the months that the index has risen above the strike price of the index call.
Like any other asset class or fund, the risk / reward profile offered by QYLD or another covered call ETF may not be suitable for all investors. However, they are likely to be of interest to retirees and income investors, who may be willing to sacrifice upside potential in exchange for more regular monthly benefits.
Market participants may wish to speak to a financial advisor to gain a deeper understanding of how such funds work. For American investors, there are also likely to be tax consequences of writing call options.