Covered Call ETFs For BIG Dividends 💴

A Mini Masterclass on Covered Call ETFs

Covered call ETFs are gaining popularity, especially among income-focused investors.

These are funds that pay BIG dividends, typically on a monthly basis.

But what are they? And how can they fit into your portfolio?

In this article, we’ll explore the ins and outs of covered call ETFs, their potential benefits, and the trade-offs you should consider.

---

What Are Covered Call ETFs?

Covered call ETFs are funds that use a specific income-generating strategy: selling call options on stocks they own.

Here’s how it works:

• The ETF holds a portfolio of stocks.

• It sells call options, which allows the ETF to earn a premium

• The income generated from premiums is distributed as income to investors.

This strategy allows covered call ETFs to payout big dividends on a monthly basis.

---

4 Things You Need to Know About Covered Call ETFs

1. Monthly Payouts May Fluctuate

   The payouts from covered call ETFs can greatly fluctuate. Pictured below is an example of this from the covered call ETF, JEPI:

   

   While some covered call ETFs’ payments monthly may fluctuate dramatically, others experience much more consistent yields as shown below with SPYI.

   

2. Volatility Impacts Their Performance
   The premiums these funds generate depend on market volatility. Higher volatility typically leads to higher premiums and larger payouts, while lower volatility can result in reduced income. This makes their performance partly dependent on market conditions. For example, notice the material jump in income shown above between both JEPI and SPYI between August and September 2024. This was caused by the VIX (market index that measures the implied volatility of the S&P 500) skyrocketing on August 5th.

3. Capped Upside Potential
   Selling call options caps the upside potential of the underlying stocks, as gains are limited to the strike price of the options. With that being said, it’s becoming more common for these funds to write call options against only 70-80% of the portfolio's value, allowing the other 20-30% to be “uncapped” and move freely with the markets.

4. Downside Protection

   Premiums collected from call options can partially offset losses if the underlying stock prices decline.

---

Popular Covered Call ETFs

Some of the most well-known covered call ETFs include:

• JEPI: JPMorgan Equity Premium Income ETF (7.21% Yield)

• QYLD: Global X NASDAQ 100 Covered Call ETF (12.26% Yield)

• XYLD: Global X S&P 500 Covered Call ETF (11.39% Yield)

However, not all covered call ETFs are made equal.

For example…

• QYLD is down 21.5% since inception in 2015.

• XYLD is down 6.41% since inception in 2015.

While JEPI is up 17.15% since inception, the majority of the income generated from JEPI is taxed as ordinary income, thus leading to higher tax rates.

---

A Newcomer Covered Call ETF…

What if there was a covered call ETF that:

1. Gave you upside exposure to the market

2. Paid out big monthly dividends

3. Was more tax efficient than your typical covered call ETF

That’s what the team at NEOS just launched, with their NEOS Real Estate High Income ETF, IYRI.

If you have REITs in your portfolio or on your watchlist, and are looking to get an additional boost of income, IYRI could be a good option for you.

You can learn more about this covered call ETF by going to their website here and reading their prospectus.

---

Advantages of Covered Call ETFs

1. High Yields
   Covered call ETFs often offer double-digit yields, significantly higher than traditional dividend ETFs.

2. Lower Volatility
   By selling options, these ETFs may experience less price fluctuation compared to holding the underlying stocks directly.

3. Consistent Income
   Monthly distributions make these funds attractive to income-focused investors, such as retirees.

---

The Trade-Offs

1. Capped Upside
   When stock prices rise sharply, covered call ETFs won’t capture the full upside due to the sold options.

   For example, during bull markets, a fund like QYLD may underperform compared to broader market ETFs like SPY.

2. Dividend Volatility
   Income from covered call ETFs isn’t fixed. Premiums depend on market volatility—when volatility declines, so does the income.

3. Higher Fees
   Covered call ETFs often have higher expense ratios compared to traditional index funds.

   • SPY: 0.09%

   • JEPI: 0.35%

   • QYLD: 0.61%

4. Tax Implications
   Income generated from option premiums is usually taxed as short-term capital gains, which can be higher than long-term capital gains rates. Keep an eye out for terms like “Return of Capital” and “Section 1256 Contracts” when reviewing a prospectus, as these often mean tax-efficiency.

   ---

Are Covered Call ETFs Right For You?

Here’s the definitive answer:

It depends.

It depends on your goals, risk tolerance, and investing time horizon.

As we saw above, Covered Call ETFs have some clear benefits-

But there are trade offs.

Know what type of investor you are, and act accordingly!

---

Check out these resources:

Tickerdata 🚀 (My automated spreadsheets and instant stock data for Google Sheets!)

Interactive Brokers 💰 (My favorite place to buy and sell stocks all around the world!)

Seeking Alpha 🔥 (My favorite investment research platform!)

The Dividend Report 📊 (Free Newsletter for Straightforward Dividend Stock News)

---

At the start of every month, I send out a newsletter to my paid newsletter subscribers with a list/spreadsheet of all the dividend stocks that I believe to be currently undervalued.

If you’d like to receive this sheet, you can sign up here:

---

That’s all for now!

See you next week!

Dividendology 🚀