Archive for May, 2011

An Introduction to Covered Call ETFs

May 29, 2011


If there is an ‘it’ thing in investing today, it is ‘income’ products. You don’t have to look far to find the reasons. Bond yields, even adjusted for inflation, are pitifully low. Dividend yield on the overall market is still stuck at generational lows and capital gains are hard to come by. So, when BMO introduced a Covered Call Canadian Banks ETF (ZWB) early this year with a mouth-watering targeted yield of 9%, it was met with intense investor interest. In less than six months since its introduction, ZWB has gathered $280 million in assets. This week, we’ll take a closer look at ZWB and a clutch of covered call ETFs from Horizons AlphaPro.

What is a Covered Call or Buy Write Strategy?

Covered Call Writing is a conservative options strategy that allows investors to earn extra income from their stock portfolio by writing (i.e. selling) call options. A call option gives the buyer the right to buy a stock at the strike price any time before the expiration date. In exchange for earning options premiums, investors are giving up some of the upside of their stock holdings. Check out The Rookie’s Guide to Options by Mark Wolfinger for an excellent explanation of the Covered Call Strategy. You can also learn about this options strategy on the CBOE website.


The obvious benefit of a covered call strategy is that it allows investors to earn extra income from their portfolio by selling covered calls. The premium income plus the dividend yield of the underlying portfolio would be very attractive to an investor relying on her investments for income. Another benefit, at least according to this study by Ibbotson that looked at historical performance of a covered call strategy, is lower portfolio volatility. An ETF allows investors to take advantage of a covered call strategy without having to implement it themselves.


By its very definition, a covered call strategy limits the upside potential of a portfolio in bull markets. Investors who are in their accumulation stage will likely prefer the tax advantages and lower cost of buying-and-holding plain vanilla stock index ETFs.

In tomorrow’s post, we’ll take a closer look at the Ibbotson study that analyzed past performance of the CBOE S&P 500 BuyWrite (BXM) Index.

Further Reading

BMO ETFs explains Covered Call Options Strategy.
Horizons BetaPro’s Eden Rahim explains Covered Call Strategies.

A Foolproof Method to Convert Canadian Dollars into US Dollars

May 25, 2011


The traditional Norbert Gambit takes advantage of inter-listed Canadian stocks (RIM on the TSX and RIMM on NASDAQ, for example) but many investors find that discount brokers sometimes balk at journaling shares to the US account and selling shares right away. This would mean a wait of three trading days for the initial trade to settle and another two business days for the shares to be journaled over and taking on market and securities risk during the waiting period.

Recently, Horizons BetaPro introduced the US Dollar Currency ETF that trades on the TSX under the ticker symbol DLR. DLR is a currency ETF that simply holds US dollar cash equivalents and trades in Canadian dollars. Horizons BetaPro then followed it up with a US dollar denominated version of the same ETF that also trades on the TSX under the ticker symbol DLR.U. The combination of DLR and DLR.U allows investors to execute a Norbert Gambit and convert Canadian dollars into US dollars or USD into CAD at a very low cost without taking on any security risk.

Here’s how you can use DLR to convert Canadian dollars into US dollars.

1. Get a quote on DLR after logging in to your discount broker. Make sure that the bid-ask spread is 2 cents.
2. Since DLR has very low volume put in a limit order at the current ask price.
3. Wait for the trade to settle (T+3 days). Call your discount broker to journal DLR to your US investment account.
4. Wait 2 business days for the shares to get journaled over.
5. Get a quote on DLR.U. Make sure that the bid-ask spread is 2 cents.
6. Put in a limit order at the current bid price.
7. When the trade is executed, you’ll have converted CAD into US dollars.

To convert USD into CAD, investors would purchase DLR.U in their US investment account and sell DLR in their CAD investment account. The typical discount broker charges 1.5 to 2 percent on currency conversions. Norbert Gambit with DLR/DLR.U will cost an investor just two trading commissions plus 2 cents spread per share.

Here’s a concrete example from a recent currency conversion I did in my TD Waterhouse account.

Purchase 500 shares of DLR at $9.75.
Sell 500 shares of DLR.U at $9.99.
Result: $4,885 CAD converted into $4,985 USD.
TD Waterhouse retail exchange rate: $4,885 CAD converted into $4,943 USD.
Total Savings: $42

Update #1:
The low trading volume of DLR/DLR.U is not a concern because ETF vendors (Horizons BetaPro in this case) typically work closely with market makers to ensure tight bid-ask spreads.

Update #2:
When you journal DLR over to the US Dollar account, the ticker symbol may remain the same. However, you will be able to put in a sell order for DLR.U. Don’t forget to note down the bid price of DLR because the difference between your purchase price and sell price in Canadian dollars should be declared as capital gains or losses in your taxes.

Update #3:
Here’s another example of a currency conversion with DLR/DLR.U:

Buy 700 DLR at $9.75.
Sell 700 DLR.U at $9.99
Result: $6,835 CAD converted into $6,983 USD.
TD Waterhouse retail exchange rate: $6,835 CAD converted into $6,901 USD.
Total Savings: $82

This and That: Advisors, Millionaires and more…

May 19, 2011

  1. Many “financial advisors” in Canada are simply mutual fund salespeople. This article on Morningstar weighs in on how to tell true advisors and product pushers apart.
  2. A recent report said that as many as 1.7 million households in Canada are worth more than $1 million. Garry Marr writing in the Financial Post explains why this isn’t as big a deal as it first appears.
  3. Globe & Mail’s John Heinzl weighs in on the question of how often to rebalance a portfolio.
  4. Preet Banerjee explains what dollar value averaging is and why it might be better than dollar cost averaging.
  5. Housing bubble? What housing bubble? Apart from Vancouver and surrounding areas, there is no housing bubble in Canada says Larry MacDonald.
  6. Boomer and Echo offered some useful tips on how to use e-post to organize and manage bills.
  7. Options are something I’ve never dabbled in. Million Dollar Journey has written up a step-by-step guide to writing covered call options.
  8. Money Smarts Blog has some useful pointers for parents who are planning on setting up RESPs for older kids.
  9. Canadian Couch Potato investigates how many actively-managed mutual funds outperformed a globally diversified index fund portfolio over a 10 year period.
  10. Michael James explains why he is sceptical of the rule that says you should cut your losers and let your winners run.

I’m unable to highlight all the articles worth checking out in my weekly round-up but you can check them out through my Twitter feed.

Have a great Victoria Day long-weekend everyone!