Technology is one of the best-performing sectors this year and its income profile is improving. Investors can capitalize on both themes while reducing portfolio risk with the Global X Nasdaq 100 Covered Call ETF (QYLD ).
QYLD is an income-generating spin on the Nasdaq-100 Index (NDX), an index lightly allocated dividend-offending sectors, such as energy and real estate while heavily allocated to leaders with strong balance sheets, such as the technology and communication services sectors. QYLD’s income is derived from writing covered calls on the NDX.
“Covered call strategies can turn volatility into an asset. This is due to a basic tenant of options investing: option premiums are positively correlated to volatility,” said Global X analyst Rohan Reddy in a recent note. “Investors can take advantage of this principle by writing or selling options contracts. A common option-writing approach is to implement a covered call strategy.”
With its covered call writing and put buying mechanisms, QYLD mitigates some of the volatility associated with tech-heavy benchmarks such as NDX.
“QYLD, for example, buys the underlying stocks in the Nasdaq 100 and writes a corresponding at-the-money (ATM) monthly call option on the Nasdaq 100 Index, continuously rolling over the contracts monthly at expiration,” notes Reddy. “This covered call strategy allows the fund to collect the monthly premium from selling Nasdaq 100 Index options while hedging against a rally in the index.”
The recent market swings show that the aging bull market rally is susceptible to sudden extreme bouts of volatility. Nevertheless, investors who are worried about further risks may turn to alternative strategies that exhibit lower correlations to traditional assets. This includes ETFs that track buy-write or covered call strategies to generate attractive yields if markets continue to slowdown in the year ahead.
Covered call strategies can potentially augment a portfolio during periods of heightened volatility. The covered-call options allow an investor to hold a long position in an asset while simultaneously writing, or selling, call options on the same asset.
“Covered call strategies can play a useful role in a portfolio not just as a yield-generator, but also as a way to potentially outperform in downturns and certain sideways markets,” said Reddy. “For QYLD, its drawdowns tend to be lower in most downturns compared to the underlying Nasdaq 100 Index because the option premiums help buffer against drawdowns.”
This article originally appeared on ETFTrends.com.