Covered Call ETFs

Covered call ETFs are ETFs that underwrite options on some of the ETFs underlying securities to generate higher yields for the investors through option premiums. Typically only a percentage of the ETF holdings are underwritten, providing both income and growth opportunities. 

A call option is a contract that gives the purchaser the right, but not the obligation, to purchase a security at a pre-determined price (called the strike price), for a specified period of time. In exchange, the purchaser pays a premium to the option writer in exchange for this right. 

When an option is Out-the-Money (OTM), it means the current security price is less than the strike price. When an option is In-the-Money (ITM), it means the current security price is greater than the strike price.

In selling call options, covered call ETFs monetize volatility to generate additional yield above what would typically be earned on just the dividends alone. Additionally, they provide a slightly less volatile exposure than just holding the underlying securities. In exchange for these enhanced yields, the ETFs sacrifice some of the potential underlying growth. This means these ETFs typically perform better in flat or bear markets than their “vanilla” versions.

Volatility reflects how much the price of a security is expected to fluctuate. The higher the volatility of a given security, the higher the premium demanded by the option seller. Additionally, the “moneyness” (referring to how far ITM/OTM the option is) will influence the pricing of the option as well – the further OTM, the cheaper the option. Lastly, the computed yield generated from selling calls will be influenced by the days to expiry, given that options are contracts with finite lives.

Covered call ETFs may outperform the market in flat or bear markets. This is because the option yields generated offers limited security downside protection through the option premiums. Conversely, covered call ETFs may underperform the market in bull markets, as selling call options typically forfeits some of the underlying security’s upside potential. 

Active management is focused on deviating from a given benchmark, whereas passive management is focused on tracking a benchmark, like an index. All of Global X’s Covered Call ETFs have an underlying portfolio that tracks an index, while the options overlay is actively managed through a mix of systematic and discretionary strategies.

This usage of actively managed options overlays allows us to potentially enhance the performance of the ETFs, providing value to our investors.