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.