Following last year’s calamity in the bond market, it’s not surprising that advisors and investors are looking for new avenues through which to source income. That search is leading many market participants to options-based exchange traded funds, including covered call ETFs.
As of the end of the third quarter, nontraditional equity funds — the space in which derivatives-linked ETFs reside — hauled in more than $18 billion in fresh assets. That could prove to be good news for issuers such as NEOS, which is the issuer behind options-writing ETFs such as the NEOS Enhanced Income Cash Alternative ETF (CSHI ) and the NEOS S&P 500 High Income ETF (SPYI ).
The NEOS Enhanced Income Aggregate Bond ETF (BNDI ) is the issuer’s fixed-income-inspired offering. That ETF offers bond market exposure via the widely observed Bloomberg U.S. Aggregate Bond Market Index and bolsters the corresponding yield by selling, or writing, options contracts on the S&P 500.
Advisors, Investors Using Covered Calls
Increased interest in ETFs such as BNDI, CSHI, and SPYI isn’t simply the byproduct of last year’s chaos in the bond market. As evidenced by a recent spike in 10-year Treasury yields, that turbulence is still present, indicating some market participants find the NEOS funds appealing bond ETF alternatives.
Additionally, while the S&P 500 is higher by 10.24% year to date, the benchmark U.S. equity gauge is up just 2.59% over the past six months and has been under duress for more than a month. Declining markets highlighted the perks of options-writing ETFs because those declines limit losses on covered calls while often stoking higher options premiums, meaning for income for investors in the aforementioned NEOS funds.
“A covered-call fund owns a basket of stocks and sells a ‘call’ option on them. Should those stocks rise above a specified ‘strike’ price, the fund pays the buyer of the option the difference between the stock price and the strike price,” wrote Morningstar analyst Katherine Lynch. “However, if the stock declines or simply stays below the exercise price, the fund keeps the income paid by the option buyer.”
Options-based ETFs aren’t perfect. For instance, the funds can limit investors’ upside when the underlying asset rallies. However, in the cases of BNDI and CSHI, the options strategies offered by NEOS not only boost yield relative to bonds and cash, the possibility of modest outperformance is there. Plus, these ETFs can reduce volatility.
“Another appeal covered-call ETFs have for some investors is their lower volatility profile — specifically their buoyancy when the stock market sells off,” added Lynch.
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