7 Best Covered Call ETFs and How They Work

Covered Call P&L Graph

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The covered call strategy is a great way for risk-averse investors to make passive income in a sideways market. 

For those who already have a solid understanding of how covered calls work, we have provided a list of some of the best covered call ETFs below. 

For those who aren’t 100% certain about the mechanics of covered calls (each one is different!), please read on as understanding these various strategies is vital to understanding their performance. 

Lastly, I would like to add that most covered call ETFs are NOT passive investments. The “set-it-and-forget-it” approach does not work here. Why?

Over time, covered call ETFs tend to massively underperform the market. If you are looking at a long time horizon (such as retirement), history tells us the best approach to investing in equities is outright. However, if your time horizon is relatively short, and you are either neutral or slightly bearish on the market, covered calls may provide a great way for you to make some extra money. 

Without further ado, here’s our list! Remember, there is A LOT more to these ETFs than their dividend! A fat dividend usually coincides with forfeiture of price appreciation. 

Please read on if you have any questions as they will most likely be answered.

7 Top Covered Call ETFs

Ticker Fund Name Dividend Yield Strategy Option Strategy Expense Ratio
Global X S&P 500 Covered Call ETF
9.12%
Income
Sells at-the-money calls
0.60%
Global X Nasdaq 100 Covered Call ETF
9.92%
Income
Sells at-the-money calls
0.60%
Global X Russell 2000 Covered Call ETF
12.09%
Income
Sells at-the-money calls
0.60%
Global X S&P 500 Covered Call & Growth ETF
0.78% 30-day SEC Yield (new fund)
Income + Price Appreciation
Sells at-the-money calls on 50% of portfolio
0.60%
Global X Nasdaq 100 Covered Call & Growth ETF
0.08% 30-day SEC Yield (new fund)
Income + Price Appreciation
Sells at-the-money calls on 50% of portfolio
0.60%
X-Links™ Gold Shares Covered Call ETN
9.77%
Income + Price Appreciation
Sells out-of-the-money calls
0.65%
KNG
FT Cboe Vest S&P 500® Dividend Aristocrats Target Income ETF
3.40%
Income + Price Appreciation
Sells at-the-money calls on 20% of portfolio
0.75%

Want to skip over the covered calls tutorial and jump directly to an explanation of the above ETFs? Click Here!

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Understanding Covered Calls for Beginners

The covered call option strategy is defined as the following:

Covered Call: A financial transaction where a call option is sold against an underlying security, typically 100 shares of stock.

Components:

  • Long 100 Shares of Stock
  • Short 1 Call Option

For a complete lesson on covered calls, please make sure to check out either our video or article on the subject. 

Covered Call Example

In order to understand the utility of covered calls, let’s take a look at a quick example.

Let’s say you own 100 shares of Invesco’s QQQ ETF, which represents the Nasdaq 100. 

In this scenario, let’s assume QQQ has been reaching all-time highs every day. You think the ETF is in for a breather and will trade sideways for some time. The current price of QQQ is $375/share. 

With stock, there is no way you can capitalize off of your projected market direction. However, if you utilize options, you can make a little extra money off of a neutral share price. How?

By selling a call. Let’s say that you do not believe QQQ is going to trade above $380/share for the next month. In this situation, you could sell a call option 30 days out at the 380 strike price. We’ll say you are able to sell it for $2. 

What does that mean? As long as QQQ is trading below $380/share when your option expires, you’ll receive the full credit of $2, or $200. However, if the ETF rallies to, let’s say, $390/share, you will miss out on this price appreciation. 

When you sell a call against your stock, the most you can ever make is strike price + premium sold. In our case, once the stock goes above (380+2) $382/share, we won’t see any additional gain. For every dollar we make on the stock at these levels, we lose a dollar on the option. 

Covered Call "Moneyness"

Covered calls can either be sold out-of-the-money, at-the-money, or in-the-money. In our above examples, all covered calls are sold at-the-money, or out-of-the-money (the traditional covered approach). 

The “moneyness” of an option is determined by the strike price of that option relative to the stock price. 

Here’s how that looks on a chart:

Option Moneyness

Covered Call Performance

Markets will always be in one of three states: bearish, neutral, or bullish. The covered call strategy will profit in 2 (and sometimes 3!) of these markets.

1. Covered Call in a Bullish Market

Covered calls typically do not fare too well in a bullish market. This depends, of course, on the strike price of the call sold! If you sell an at-the-money option, you will likely miss out on price appreciation if the underlying rallies. If you sell an out-of-the-money option, and the stock doesn’t reach the strike price of the call you sold, you will win on both the income received as well as price appreciation!

2. Covered Call in a Neutral Market

Covered calls love neutral markets. In this scenario, you won’t miss out on any price appreciation. While everybody else is flat, you’ll be making a nice dividend!

3. Covered Call in a Bearish Market

Like covered calls in a bullish market, what really dictates how well a covered performs in a bear market depends on how bearish that market is.

For a minorly bearish market, the call we sell provides us some downside protection. Just subtract the premium you received from the stock price, and that’s where your losses begin to build up.

In a market correction, however, watch out! Though covered calls mitigate risk, they by no means irradicate risk; you still have A LOT of downside risk!

Let’s next look at a few pros and cons of covered call exchange-traded funds (ETFs).

Covered Call ETF Pros

1.) Income Generation

Selling a call option against your long stock creates a steady stream of income for your portfolio. Generally, covered call ETFs pay out dividends on a monthly basis, as that is the frequency that they sell calls.

The further out of the money the call you sell is, the less premium you will receive. Some covered call ETFs, like QYLD, sell at-the-money calls. That is the reason their dividend is so high. But remember, the closer the strike price is to the stock price, the less you’ll make when the stock rallies.

2.) Profit in a sideways market

With markets teetering near all-time highs, many investors believe we are in for a breather. The covered call strategy allows you to capitalize in a neutral market. If the market goes nowhere, you will collect the full premium on the call you sold.

3.) Covered Call ETFs may save time and money

Trading options is a very complex and time-consuming process. After working as an options broker in Chicago for 15 years, I can tell you that the education never stops. Investing in covered call ETFs gives you peace of mind; you don’t have to worry about “rolling” positions, nor do you have to worry about whether or not you are assigned.

ETFs employ “price stabilizers” to keep the ETF price in check, as well as fund managers to actively manage the positions. This does, however, come at a fee – most covered call ETFs I have seen charge a fee of about 0.60%. Though high when compared to other ETFs (the popular SPY ETF fee is only 0.09%), these funds certainly earn their money. Remember, trading options can be a costly endeavor in terms of time and commissions.

4.) Covered Call ETFs allow for great diversification

A lot of the funds on our list go out and actually buy all of the securities within the index. That’s a lot of work! Can you imagine how much it would cost to buy all of the stocks within the Nasdaq 100 on your own?

5.) Covered Call ETFs have no assignment risk

When you are trading covered calls on your own, you are at risk of being assigned on your short call at times when the extrinsic value is low, or when the underlying issues a dividend (dividend risk). ETF managers take care of this for you, mostly by selling capitalize in a neutral market (European style options) which have no early-assignment risk as opposed to options on traditional stocks and ETFs (American style options).

Covered Call ETF Cons

1.) Upside limited to strike price + premium sold

Covered calls are not great investments for bullish markets. That is assuming an alternative for your investment strategy was to invest directly in the stock. After the stock surges beyond your strike price + premium sold, you will see no additional profit.

2.) Covered calls have massive stock risk

Though the covered call strategy does indeed limit the risk of an equity position, it by no means eradicates that risk. After you account for the discount of the premium you sold, a covered call loses money on a 1:1 basis with the stock. 

3.) Poor performance in volatile sectors

The more volatile the underlying, the higher the dividend you will receive. But trading covered calls in very volatile sectors, such as energy, can wipe your account out. How? 

Let’s say oil is trading at $100 a barrel and you own an ETF that matches this price, meaning the ETF tracks oil and is currently trading at $100/share. Let’s say oil plummets to $20/barrel. If you took in $5 for an at-the-money-call when the stock was at $100, your max loss would be $95/share. Your at-risk expose is still $95/share!

But that’s ok, because when oil rallies, you’ll be included in it, right? Nope. If you’re trading a covered call on oil, your upside IS LIMITED TO STRIKE PRICE PLUS PREMIUM. 

Take a look at how Credit Suisse X Links Crude Oil Shares Covered Call ETN USOI (blue line) compares to a non-covered oil ETF (orange line). Remember, this chart doesn’t account for USOI’s fat dividends, but if you wanted to be long oil, you would have surely missed out!

USOI vs DBO
Covered oil ETN (blue) vs non-covered oil ETF (orange) - Google Finance

XLYD, QYLD and RYLD ETFs Explained

The covered call ETF’s XLYD, QYLD, and RYLD (offered by Global X) all employ selling an at-the-money call representing 100% of their underlying portfolios. Respectively, they track the S&P 500, the Nasdaq 100, and the Russell 2000.

The closer your call is to being in-the-money, the more premium you will receive. It is because of this these three ETFs all have the highest dividends on our list. 

But remember! When you sell at-the-money calls, you don’t participate in much price appreciation. And following a market crash, it may take a very long time indeed for your share price to play catch up.

For example, all markets crashed when the pandemic hit, but the Nasdaq soared on the tail of Covid. When you sell a covered call, however, your upside is limited to the premium received. This means that the QYLD fund participated very little in Nasdaq’s rally, as illustrated in the below 3-year chart comparing QYLD (purple) to its benchmark, the Nasdaq, as represented by QQQ (orange line).

QYLD vs QQQ
QYLD vs QQQ - Source: ycharts

The above chart represents the downside to covered call ETFs. There is, however, a pretty great upside. In an environment where the stock is stagnating, you’ll still be making a nice fat dividend. These three ETFs pay between 9 and 12% annually!

XLYG and QYLG ETFs Explained

XLYG and QYLG are two relatively new funds offered by Global X. Their representative indexes are the S&P 500 and the Nasdaq 100, respectively. 

Similar to XLYD, QYLD, and RYLD, these funds sell one-month at-the-money calls on their indexes. However, there is one huge difference  – XLYG and QYLG only sell these calls on 50% of their stock.

What does that mean? It means the other half of the equity is free to run higher (and lower) with the stock.

Since we are only selling calls on half of our positions here, it makes sense that the dividends for these two ETFs are lower. 

GLDI ETF Explained

Gold Bar

The GLDI ETF (offered by Credit Suisse X-Links) implements a covered call investment strategy in gold through the GLD ETF, which tracks the price of gold. 

This fund offers investors who are neutral to minorly bearish in gold a great way to make a little extra income. I say minorly bullish because the fund sells calls that are 3% out-of-the-money on a monthly basis. This means the ETF can run 3% higher before we start missing out on price appreciation. 

What is attractive here is the high dividend yield of 9.77%. Most of our other funds receive this kind of yield from selling at-the-money calls. But remember, gold is a lot more volatile than the S&P 500! The premium here is justified by the volatility in the underlying. 

KNG ETF Explained

Last on our list is the KNG ETF, offered by First Trust. This fund tracks the S&P 500 Dividend Aristocrats Target Income Index.

Like XLYG and QYLG, this ETF is a hybrid fund. Here’s how First Trust describes its fund:

"... seeks investment results that correspond generally to the price and yield (before the Fund's fees and expenses) of an equity index called the Cboe S&P 500® Dividend Aristocrats Target Income Index Monthly Series (the "Index"). The Fund will normally invest at least 80% of its total assets (including investment borrowings) in the common stocks and call options that comprise the Index. The Fund, using an indexing investment approach, attempts to replicate, before fees and expenses, the performance of the Index."

First Trust

Perhaps most important is the low option exposure this ETF has: covered calls are written on a notional value of no more than 20% of the value of each underlying Aristocrat Stock.

This low covered call exposure is the reason for its relatively low dividend yield of 3.40%. This is a great ETF for minorly bullish investors on the S&P 500 Dividend Aristocrats Index. 

Final Word

So what do we take away from all of this? ETFs are a great way for novice and advanced traders alike to participate in the covered call strategy. There are downsides as well as upsides. It is not free money; you are giving up A LOT when you decide to invest in a covered call ETF. Having a solid grasp of how options work is a prerequisite.

Check out some of our recommended reading if you’d like to learn more about options trading!

What are your thoughts on covered call ETFs? Are they worth it? Let me know in the box at the bottom of this page!

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Mike Martin

Mike Martin

Mike was a writer for projectfinance. He has spent over 15 years in the finance industry, working for such companies as thinkorswim, TD Ameritrade and Charles Schwab. His work has appeared in the Financial Times, the Chicago Sun-Times, and The Buffalo News.

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2 thoughts on “7 Covered Call ETFs and How They Work

  1. Hey Ted!

    Covered call ETFs are generally not the best products for retirement accounts – at least for those with several years until they retire. Why? These funds are costly, often 5x more expensive than an index-tracking ETF would be. Additionally, covered call ETFs don’t recover as fast from market downturns as index-tracking ETFs do – that short call really limits upside price appreciation! These ETFs are best for relatively active investors. Hope this helps!

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