Maximize Monthly Income with these 5 Covered Call ETFs

Table of Contents

1. What Are Covered Call ETFs?
2. How Covered Call ETFs Generate Income
3. Key Advantages and Potential Risks
4. Main Strategies and Portfolio Construction
5. Notable Covered Call ETFs
   • QYLD (Global X NASDAQ 100 Covered Call ETF)
   • XYLD (Global X S&P 500 Covered Call ETF)
   • RYLD (Global X Russell 2000 Covered Call ETF)
   • JEPI (JPMorgan Equity Premium Income ETF)
   • DIVO (Amplify CWP Enhanced Dividend Income ETF)
6. Tax Considerations
7. How to Choose the Right Covered Call ETF
8. Conclusion

1. What Are Covered Call ETFs?

Covered call ETFs are funds designed to generate income for shareholders by writing (selling) call options against an existing equity portfolio. The word covered signifies that the underlying securities (stocks) owned by the fund cover the options contracts sold. This approach can potentially offer a steady stream of distributions—often paid monthly—thereby attracting investors seeking additional income beyond standard dividends.

Simplified Mechanics

1. Own the Stocks: The ETF invests in an index or a basket of stocks.
2. Sell Call Options: The ETF sells (or writes) call options on some or all of those stocks.
3. Option Premium: By writing call options, the ETF collects option premiums, which can be passed on to shareholders as part of the fund’s distribution.

This options-based strategy can help increase income but also places a cap on some upside potential if the underlying stocks rally significantly above the strike price of the calls sold.

2. How Covered Call ETFs Generate Income

The main driver of returns for covered call ETFs is the premiums collected from selling call options. While typical equity ETFs earn income through capital appreciation and stock dividends, covered call ETFs add another income layer via option premiums. These collected premiums are often passed along to investors on a regular basis, typically monthly or quarterly, with many popular funds opting for monthly distributions to appeal to income-seekers.

Key Benefits of Option Premiums

• Enhanced Income: The premium boost can result in higher yield compared to a pure equity holding.
• Partial Downside Protection: The premium earned provides a cushion during minor market pullbacks, although it is generally not substantial enough to protect against severe downturns.

3. Key Advantages and Potential Risks

Advantages

1. High Income Potential
   Covered call ETFs may offer above-average yields. Investors looking for monthly income—such as retirees—may find this especially appealing.
2. Reduced Volatility
   By collecting option premiums, the fund offsets some of the losses in a down or sideways market. Though this does not eliminate risk, it can moderately dampen volatility compared to a pure equity strategy.
3. Ease of Implementation
   Rather than writing calls on individual stocks themselves, investors can outsource the complexity to professional managers through a covered call ETF. This avoids the need for in-depth options knowledge and transactions in personal brokerage accounts.

Potential Risks

1. Limited Upside
   By selling call options, you forfeit gains beyond the strike price of the calls. If the market rallies strongly, covered call ETFs typically underperform the underlying index.
2. Dividend and Premium Fluctuations
   If market volatility declines, option premiums earned may be smaller, reducing the fund’s yield. Distributions can fluctuate more than typical equity dividends.
3. Management Style
   Some funds write calls at-the-money, whereas others may write out-of-the-money or only on a portion of the portfolio. These nuances impact both risk and return. Understanding each fund’s strategy and coverage ratio is crucial.

4. Main Strategies and Portfolio Construction

Covered call ETFs differ primarily in:

• Underlying Index: S&P 500, NASDAQ 100, Russell 2000, etc.
• Option Coverage Ratio: The percentage of the portfolio against which the fund writes calls (e.g., 100% coverage, 50% coverage, or a dynamic approach).
• Option Moneyness: Some funds might write calls at-the-money (collecting higher premiums but capping upside more aggressively), while others may choose out-of-the-money strikes (slightly lower premiums but greater potential for capital appreciation).

These factors affect overall yield, total returns, volatility, and risk profile.

5. Notable Covered Call ETFs

5.1 QYLD — Global X NASDAQ 100 Covered Call ETF

• Strategy: QYLD aims to track the Cboe NASDAQ-100 BuyWrite V2 Index. It invests in the Nasdaq 100 stocks and writes at-the-money call options on the index.
• Income: Known for high monthly distributions.
• Upside Potential: Writing calls at-the-money generally results in minimal upside participation if the Nasdaq rallies significantly.
• Considerations: Offers an above-average yield, but capital appreciation may be constrained in a strong bull market. Historically, QYLD has maintained stable distributions, making it a popular choice among income-focused investors.

5.2 XYLD — Global X S&P 500 Covered Call ETF

• Strategy: Similar to QYLD, except its underlying index is the S&P 500. XYLD writes at-the-money calls on the S&P 500.
• Income: Known to distribute a slightly lower yield than QYLD on average, but it tracks the broader, more diversified S&P 500.
• Upside Potential: Again, capped by the at-the-money call strategy.
• Considerations: Can be attractive for those seeking monthly distributions but prefer an S&P 500 base.

5.3 RYLD — Global X Russell 2000 Covered Call ETF

• Strategy: Tracks the Cboe Russell 2000 BuyWrite Index, investing in smaller-cap U.S. companies.
• Income: Offers a high yield, often comparable to QYLD, with monthly distributions.
• Risk Profile: The small-cap market can be more volatile. However, the covered call premium can somewhat offset the additional volatility.
• Considerations: Suited to those who want covered call exposure to small-cap stocks for potential diversification and a strong yield.

5.4 JEPI — JPMorgan Equity Premium Income ETF

• Strategy: JEPI invests primarily in large-cap U.S. stocks and uses equity-linked notes (ELNs) to generate option income.
• Income: JEPI aims to deliver an attractive monthly distribution, typically lower than QYLD but with higher total returns historically.
• Upside vs. Downside Protection: Because it actively manages the options overlay, it may allow more participation in upside while still providing considerable income.
• Considerations: JEPI’s strategy is slightly more complex than a straightforward buy-write approach, as it involves ELNs. It has gained notable popularity due to its blend of income and potential for capital appreciation.

5.5 DIVO — Amplify CWP Enhanced Dividend Income ETF

• Strategy: DIVO invests in dividend-paying stocks and writes covered calls on a portion of the portfolio.
• Income: Distributions come from dividends plus option premiums, paid monthly.
• Upside Potential: Because it writes options only on a portion of holdings, it can participate more in market rallies.
• Considerations: DIVO often exhibits slightly lower yield than full coverage buy-write ETFs like QYLD or RYLD but aims for higher total return potential through partial coverage and strong dividend stocks.

6. Tax Considerations

Covered call strategies involve options premiums, which can be subject to short-term capital gains rates or treated differently based on the holding period, strike price, and other factors specific to options taxation. Meanwhile, fund distributions may come as a mix of qualified dividends, non-qualified dividends, and return of capital—depending on the ETF’s activity.

• Return of Capital (ROC): Some covered call ETFs use ROC, which reduces your cost basis rather than being counted as ordinary income. This can create tax efficiencies in the short term but might result in higher capital gains down the road when you sell shares.
• International Investors: Tax rules will vary based on your country of residence. Consult a local tax professional for specific guidance.

7. How to Choose the Right Covered Call ETF

1. Underlying Index Exposure
   • Consider whether you want large-cap (S&P 500, Nasdaq 100) or small-cap (Russell 2000) exposure.
2. Coverage Ratio & Option Strategy
   • 100% covered calls vs. partial coverage. At-the-money vs. out-of-the-money. These distinctions dramatically influence both income and growth potential.
3. Yield vs. Total Return
   • Higher yield funds often cap upside more aggressively. If you need absolute highest monthly income, look to QYLD, XYLD, or RYLD. If you want a balance of growth and income, JEPI or DIVO may be more fitting.
4. Liquidity and Expense Ratios
   • Always check volume and total assets under management (AUM). Also consider expense ratios since those costs directly reduce returns.
5. Risk Tolerance and Time Horizon
   • Covered call ETFs are not immune to losses in a bear market. Assess your comfort level with volatility and your long-term investing goals.

8. Conclusion

Covered call ETFs can be an appealing solution for income-oriented investors seeking monthly distributions above typical dividend yields. By writing calls on their equity positions, these funds tap an additional source of income—option premiums—while providing some measure of downside cushion (though not full protection).

• QYLD, XYLD, and RYLD deliver robust yields by writing calls at-the-money on large and small-cap indexes.
• JEPI attempts to balance premium income with equity market participation.
• DIVO focuses on dividend growth stocks and selectively writes calls for both yield and growth potential.
• NUSI incorporates a protective put to mitigate downside risk.

As always, be aware of the limitations of covered call strategies—namely the capped upside potential in bull markets, varying monthly distributions, and potential tax complexities. Evaluate your risk tolerance, investment objectives, and speak with a qualified financial advisor before allocating capital. With prudent research and consideration, covered call ETFs can be a valuable addition to a well-diversified, income-focused portfolio.