When stocks move up in near straight-line fashion, covered call exchange traded funds are nice income generators, but these ETFs will also lag the broader market's returns.
It is during volatile market stretches that the utility of covered call ETFs shines through. That has been the case in recent weeks as investors have eagerly departed momentum sectors in favor of less volatile fare.
The idea behind covered call ETFs, reports Tom Lauricella for the Wall Street Journal:
[I]s that over the long term, an investor will earn stock-like returns with fewer ups and downs. The chief drawback is that this strategy caps gains in the kind of big stock rally seen during 2013, when the S&P 500 rose 30%.
Year-to-date, the S&P 500 is up just 0.7% and the benchmark U.S. index yields a paltry 1.9%. The Horizons S&P 500 Covered Call ETF (NYSEARCA:HSPX) is higher by 1.2%. HSPX tracks the S&P 500 Stock Covered Call Index, so its equity positions and weights mirror those found in the S&P 500.
Additionally, Horizons ETF offers a more tactical approach with the Horizons Financial Select Sector Covered Call ETF (NYSEARCA:HFIN), which tracks the S&P Financial Select Sector Covered Call Index.
By utilizing a covered call strategy, an investor who owns a stock sells call options, and collects the income from the premiums paid by the buyer of the option. Specifically, the underlying index utilizes an "out-of-the-money" covered call strategy. The out-of-the-money call option will take a strike price higher than the current market price of the underlying security.
The $248.8 million Powershares S&P 500 BuyWrite Portfolio (NYSEARCA:PBP) has almost doubled the returns offered by the S&P 500 this year. PBP follows the CBOE S&P 500 BuyWrite Index. Both PBP and HSPX could garner increased attention if market volatility increases as 2014 moves.
With momentum sectors such as biotech and social media being taken to task on a near daily basis, there is another covered call ETF for investors to consider, particularly because so many high beta stocks trade on the Nasdaq. The Recon Capital NASDAQ-100 Covered Call ETF (NASDAQ:QYLD) debuted last year and can help investors deal with some of the volatility associated with a market decline caused by high momentum stocks.
Horizons S&P 500 Covered Call ETF
ETF Trends editorial team contributed to this post.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.