A combination of high inflation and numerous policy interest rate hikes from the Bank of Canada created strong headwinds for equity and fixed-income assets alike, with both suffering drawdowns.
Investors looking to adapt to the current macroeconomic environment should consider the benefits of options writing strategies – in particular, using ETFs that implement a covered call overlay.
Covered call ETFs can help mitigate downside volatility in client portfolios, enhance income yield, and still allow decent participation in upside returns.
Covered call use cases
Current market conditions have reduced the viability of traditional income-generating assets like REITs, corporate bonds, preferred shares, and dividend stocks. Using covered calls instead can help investors better target a desired risk/return profile for their portfolio.
Investors in the withdrawal phase can use covered calls to potentially enhance yield. The premium received can be used for income instead of having to sell shares. Selling covered calls when volatility trends high can significantly increase premiums, leading to greater income potential.
Investors concerned about preservation of capital but unwilling to pay for a hedge or go to cash can use covered calls to provide a degree of downside protection without having to give up gains completely. Finally, options premiums are taxed favourably as capital gains, making covered calls highly tax efficient.
Why use a covered call ETF
While investors can manually write calls on their underlying stock holdings, this approach can be costly and time consuming for those not familiar with the use of derivatives.
Option volatility, time to expiry and moneyness of option should all be taken into consideration when determining the optimal strike price and expiry date. If a call goes in-the-money, investors must decide whether to wait until expiry, roll the expiry date out further, or roll the strike price up higher.
An easier, hands-off solution is using an ETF that implements a covered call overlay. In this case, the fund manager is responsible for writing and managing a portfolio of equities with covered calls sold on a portion of the holdings.
Investors who buy shares of this ETF pay a management expense ratio (MER) for exposure. In return, they received the capital appreciation from the underlying shares and distributions from the covered calls.
Our covered call ETF's write monthly at-the-money call options on 25% of their underlying holdings, which consists of an equally weighted stocks in different market sector.
Source: CI Global Asset Management, as of August 31, 2022.
1 Gross Option Premiums represent those received on August 19, 2022
2 As of September 2, 2022. The Current Dividend Yield represents the gross yield on the ETF’s underlying portfolio of securities. It is not the yield or the distribution investors will receive by virtue of an investment in the ETF.
CI Tech Giants Covered Call ETF (TXF / TXF.B / TXF.B)
Mega-cap tech stocks suffered losses recently as interest rates rose amid less-than-stellar earnings reports. The sector has been highly volatile recently, with the tech-heavy Nasdaq 100 Index down over -29% YTD (as of May 24th, 2022)amidst a bear market.
Holding TXF can provide exposure to the growth of mega-cap tech stocks while still providing downside protection. When volatility trends higher, TXF's distribution yield increases thanks to the higher premiums received from the covered call overlay.