Covered call ETFs have proven to be one of the brighter spots in the ETF landscape this year. Offering an income added on top of an underlying index, covered call strategies were once far more exclusive.
Since the ETF wrapper brought covered call option strategies to a broader audience, their popularity has grown, but so too have questions about how they work. As such, investors may want to take a closer look at a strategy like the KraneShares China Internet and Covered Call Strategy ETF (KLIP ).
Covered call ETFs involve writing call options, options that generate a profit by selling that option on a long-positioned asset. The call option buyer is obligated to pay a premium, limiting losses should that asset lose value. In KLIP’s case, the strategy operates as a “fund-of-fund” ETF that adds a covered call layer on top of the KraneShares CSI China Internet ETF (KWEB ). It does so via selling call options “European style." In that case, the options can only be exercised as they expire each month.
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The strategy’s index within KWEB focuses on China-based internet stocks. The overall strategy KLIP employs should limit volatility and add income to a portfolio. That approach has helped KLIP return 11.1% over the last three months. Those returns came despite KLIP only launching in January this year, charging a 95 basis point fee.
Covered Call ETFs and "NAV Erosion"
All that being said, however, some investors may have concerns about the idea of “NAV erosion.” When a strategy pays out some kind of current income that relies in part on an index failing to soar, that may prompt some to be concerned that the fund’s NAV may weaken. To some, they see that payout potentially limiting how much a fund can reinvest.
However, to clarify for an ETF like KLIP, if KWEB were to decline in value over a given period, that would be the culprit for a reduction in NAV, not distributions. Indeed, a declining NAV based on KWEB’s performance would not impact KLIP’s distributions, either. In fact, such periods would possibly deliver higher distributions.
Taken together, covered call ETFs provide an intriguing option and have been a big player for ETF markets this year. KLIP can not only provide income on China-based volatility, but could benefit from a possibly good 2024 via its investment in KWEB.
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