Covered call strategies have become a very popular fund type in recent years. By leaning on the options market, covered call funds offer high levels of income but can limit upside. That tradeoff has been costly over time, and with markets performing well, it’s worth asking if the sacrifice is worth it. Innovation in the covered call strategy space may offer a solution.
What specifically do covered call strategies offer? A covered call strategy can provide exposure to the equity market with a high degree of current income earned from selling options. The equity portion can involve an actively managed portfolio or track an index like the S&P 500. Such a fund may track the S&P 500 or another popular index. From there, the strategy can sell call options on some or all of the portfolio’s stocks.
The Ups & Downs of a Covered Call Strategy
With even more detail, one can begin to see a potential issue that separates the covered call wheat from the chaff. Most covered call strategies use options that expire on a monthly basis. If the portfolio’s stocks rally through the “strike price” of the option that is sold, the fund no longer benefits. Investors of the covered call strategy can potentially forgo weeks’ worth of growth. Since markets tend to appreciate over time, sacrificing returns can be a big hurdle for meeting portfolio goals.
Enter daily call options. By selling call options on a daily basis, funds like the ProShares S&P 500 High Income ETF (ISPY ), can get generate high levels of income while targeting the returns of the S&P 500. ISPY charges 55 basis point for its approach.
This innovative approach has helped ISPY return 13.5% YTD and deliver an impressive 9.8% 12-month distribution rate, per ProShares’ data as of September 30. ISPY has outperformed its ETF Database Category average, per ETF Database data, as well. Looking ahead ProShares’ strategy based on daily call options may stand out as a more appealing type of covered call approach.
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