Search For Income: S&P 500 Covered Call ETFs
Summary
- In searching for income, I researched the five largest S&P 500 covered call ETFs.
- The dividend yields of the five funds ranged from 1.09% to 9.85%.
- After examining the data, I determined that DIVO was the most attractive ETF in the group.
In this article, I will be conducting an overview of ETFs that employ a covered call strategy for the S&P 500 (SPY). For those that are new to options, a covered call strategy involves owning a stock and then selling calls to generate additional income. What drove my decision to research these funds was I got tired of the performance of Merck (MRK), which I sold and thus I set out to find an alternate investment that had quality income. My first step was to search for other stocks yielding more than 3% that were not trading at overbought technical conditions. I found the list to be underwhelming and thus turned my sights to ETFs, specifically covered call ETFs. I already own shares of the Global X NASDAQ 100 Covered Call ETF (QYLD) as a tool to generate income. QYLD generates income very well, however, it lacks capital appreciation. Since I am trying to replace Merck, I wanted a fund with capital appreciation potential and income.
S&P 500 Covered Call ETFs
The table below shows the five S&P 500 covered call ETFs I found that have assets above $100 million. While all five of these funds are in the same category, each has their own unique strategy, which leads to the funds have a wide range of returns and yields. In this section, I will be breaking down the selection strategy & covered call strategy of each fund and then in the following section I will compare each fund on a number of data points.
Symbol | Description | Assets |
(DIVO) | Amplify CWP Enhanced Dividend Income ETF | $584.38M |
(XYLD) | Global X S&P 500 Covered Call ETF | $409.78M |
(SIXH) | 6 Meridian Hedged Equity-Index Option Strategy ETF | $244.65M |
(KNG) | FT Cboe Vest S&P 500 Dividend Aristocrats Target Income ETF | $225.27M |
(PBP) | Invesco S&P 500 BuyWrite ETF | $170.47M |
Amplify CWP Enhanced Dividend Income ETF-DIVO
DIVO is actively managed and the selection pool starts with companies from the S&P 500 that pay a dividend. DIVO also looks at other fundamental metrics like earnings and cash flows as part of their consideration for individual holdings. Once stocks are selected, DIVO over-weights companies in sectors that are outperforming relative to the overall market. Finally, DIVO has sector and individual holdings constraints, which limit holdings to 25% in one sector and 8% for individual holdings.
The covered call strategy for DIVO is unique since the fund is actively managed and the managers are not required to write options on all the underlying holdings. This allows the fund to capture potential upside compared to other covered call funds that write covered calls for all their underlying holdings.
Additional information can be found in the DIVO prospectus
Expense Ratio: 0.55%
Dividend Yield: 4.88%
Global X S&P 500 Covered Call ETF-XYLD
XYLD has no stock selection process other than it holds all the individual companies that are in the S&P 500 index.
The covered call strategy for XYLD entails writing calls on the S&P 500 index and XYLD does not write calls on individual holdings. This ETF is very straight-forward and easy to understand.
Additional information can be found in the XYLD prospectus
Expense Ratio: 0.60%
Dividend Yield: 9.85%
6 Meridian Hedged Equity-Index Option Strategy ETF-SIXH
SIXH is actively managed and the stock selection process targets high quality large cap companies ranked using a number of financial metrics to measure growth, profitability, and debt servicing. An interesting criteria the fund uses is it excludes companies with low momentum. Once those series of screens is done, companies that remain are ranked by beta, momentum, yield, value, and quality and then the fund uses how each company ranks in those categories to determine the weight in the fund. Finally, an interesting feature of SIXH is the fund can hedge its portfolio with inverse ETFs.
The covered call strategy for SIXH is does not write any calls on individual holdings and instead the fund writes covered calls on the S&P 500 index.
Additional information can be found in the SIXH prospectus
Expense Ratio: 0.87%
Dividend Yield: 1.58%
FT Cboe Vest S&P 500 Dividend Aristocrats Target Income ETF-KNG
The stock selection process for KNG includes only dividend aristocrats from the S&P 500 with a market cap over $3 billion and an average daily value traded of over $5 million. Dividend aristocrats are companies that have increased their dividend for a minimum of 25 consecutive years. For the weighting strategy, KNG equally weights its holdings.
The covered call strategy for KNG entails writing calls for each individual holding of the fund, which currently entails over 60 holdings. The covered calls are written on the third Friday of each month and the options typical expire and are rolled on the third Friday of the following month. Also worth noting is the strike price of the options selected are ATM (at-the-money) meaning the option strike that is selected is close to the closing price when the options were written.
Additional information can be found in the KNG prospectus
Expense Ratio: 0.75%
Dividend Yield: 3.45%
Invesco S&P 500 BuyWrite ETF-PBP
PBP has no stock selection process other than it holds all the individual companies that are in the S&P 500 index.
The covered call strategy for PBP entails writing calls on the S&P 500 index and PBP does not write calls on individual holdings. What is intriguing is PBP has the same strategy and follows the same CBOE S&P 500 BuyWrite Index™ (Index). However, the yield for XYLD is 9.85% and the yield for PBP is 1.09%, which had me puzzled. The only differences I could find is XYLD writes index options and it appears PBP writes options on SPY. The only other difference I could find is that in the PBP prospectus, it states that the underlying index that PBP tracks reinvests dividends and option premium and there is no mention of reinvestment in the XYLD prospectus.
The Underlying Index reinvests dividends paid on the component stocks underlying the S&P 500®Index and the dollar value of option premiums received from covered call options. ~ PBP prospectus
Additional information can be found in the PBP prospectus
Expense Ratio: 0.49%
Dividend Yield: 1.09%
Fund Comparison
Now that I covered the selection and covered call strategy for each it is now time to examine the relevant data points for each fund, which include the top holdings, yield, performance and expense ratio.
Holdings
The following chart shows the top 10 holdings for each of the five ETFs I reviewed. PBP and XYLD mirror the S&P 500, so the holdings of those two funds and the weights are well known. KNG targets dividend aristocrats and is equally weighted and there are many lesser-known names in the top 10. DIVO only has 23 holdings and the top 10 are many well-known high quality companies. SIXH also has many well-known high quality companies and its top holding is interesting because it is not a stock, it is the S&P 500 SPY ETF.
Holdings data from each fund's website
Yield
I noted the yields for each fund above, but I will compile them all here in this section. XYLD by far has the largest yield and PBP has the lowest yield. XYLD is kind of an outlier in terms of yield, and the remaining four funds are split with DIVO and KNG using covered calls on individual holdings and SIXH & PBP using covered calls on the S&P 500 index. With the exception of XYLD, which also uses index options, higher yields are found in the funds that write calls on the individual holdings.
Trailing Yield | |
XYLD | 9.85% |
DIVO | 4.88% |
KNG | 3.45% |
SIXH | 1.58% |
PBP | 1.09% |
Dividend yield data from Seeking Alpha and fund website
Performance
The performance of each of the funds I covered is in the table below along with the S&P 500 for reference. So far, YTD KNG has had the best performance and XYLD has been the laggard in the group. Over the last year, DIVO had the best performance and SIXH performance laggard behind. Over the last three years, KNG was the best performing fund and PBP was the laggard, SIXH has only been around a little over a year so there is no data for it that far back. The final column I included was the 2020 drawdown in the stock market that started at the peak on February 19th 2020 and ended on March 23rd 2020. DIVO was the best performing covered call ETF during the drawdown.
YTD Return | 1 Yr Return | 3 Yr Return | 2020 Drawdown | |
KNG | 16.89% | 31.18% | 47.51% | -34.69% |
DIVO | 15.38% | 31.82% | 46.60% | -30.02% |
SIXH | 15.20% | 19.68% | NA | NA |
PBP | 11.78% | 23.69% | 12.65% | -33.67% |
XYLD | 11.65% | 24.87% | 20.08% | -34.13% |
SPY | 18.63% | 37.55% | 65.29% | -34.10% |
Performance data from etfdb.com
Expense Ratio
Looking at the expense ratios for each fund, PBP has the lowest and SIXH has the highest. As I noted in the PBP overview section above, PBP and XYLD track the same index, but have polar opposite dividend yields. To access the higher yields of XYLD that requires you to pay a higher expense ratio.
Expense Ratio | |
PBP | 0.49% |
DIVO | 0.55% |
XYLD | 0.60% |
KNG | 0.75% |
SIXH | 0.87% |
Expense ratio data from etfdb.com
Closing Thoughts
In closing, after examining the stock selection strategy, covered call strategy, and the various data points including holdings, yield, performance and expense ratio, I determined that DIVO was the most attractive fund to replace my shares of Merck. I liked the selection process for DIVO using fundamental metrics, the yield was the second highest, the performance was solid and ranked 1st or 2nd for each timeframe I examined and the expense ratio was the 2nd lowest.
In terms of risk for DIVO and covered call ETFs in general, the main risk is that upside can be capped because of the covered calls. In addition, yields can vary from month to month as volatility fluctuates so the income received each month is variable.
Many of these funds have various aspects that make them appealing to different types of investors with different goals. I have not purchased shares of DIVO, but I plan to soon.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in DIVO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Disclaimer:
The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned.
The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications or other transaction costs, which may significantly affect the economic consequences of a given strategy.
This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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