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Posted on 27 June 2012.
A covered call ETF is an Exchange Traded Fund (ETF) that sells covered calls, which is an stock option strategy in which a holder of stocks sells call options backed by their stock holdings. A covered call ETF can include a wide variety covered call option selling strategies, along with other investment and trading strategies, and therefore it is important to read the prospectus for the covered call ETF one is considering investing in to understand the specific covered calls strategies utilized and the risk associated with those strategies.
A covered call ETF makes money when they collect premiums from the buyers of the call options that the ETF sells. If the price of the underlying stocks that the call options are written for are below the call options strike price upon option expiration, then the covered call ETF keeps the premiums and has no other financial obligation to the buyer of the expired call options. A covered call ETF would then repeat this process with new call options with later expiration dates to try to continue to make money by collecting call option premiums. This is known as a buy-write covered call strategy, with the buy referring to buying stocks and the write referring to writing call options against the same stocks.
If the call options strike price is met on or before the option expiration date, and the options are exercised by the buyer of the options, then the covered call ETF would be obligated to provide the underlying stocks to the holder of the call options. The covered call ETF would not incur a loss if the options are exercised, since they already hold the underlying stocks; however, the stocks would no longer be available for writing future covered call options against, and would need to be purchased in the open market for future options writing.
There are numerous ETFs to select from when one is looking to invest or trade a covered call ETF. The following is an example of some of the covered call ETFs available.
Investing in a covered call ETF is suitable for investors that are more conservative in nature and want to hedge against stock market volatility. Covered call ETFs usually do better than the overall stock market during market declines and do not gain as much as the overall market during stock market bull rallies. The reduced volatility and sizable dividend yields associated with covered call ETFs make them particularly attractive to investors looking to earn income from stocks and keep some money in the stock market, without worrying about unexpected stock market volatility.
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