In the current landscape of potential rising rates, investors seek effective methods to optimise returns, and one compelling approach is through a covered call strategy. By acquiring stocks in a foundational index, like the S&P 500 or the Nasdaq 100, and strategically writing call options on the same index, this strategy enables investors to generate income through collected premiums.
Covered call strategies limit potential upside participation but generate income through collecting premiums from the option-writing. In volatile markets, option premiums tend to be higher and therefore, covered call strategies tend to perform best in choppy or sideways markets rather than in major bull or bear markets.
Global X ETFs offers two covered call products that are designed to offer investors alternative income solutions while potentially avoiding risks seen in traditional income-oriented investments like fixed income and dividend stocks.
The Global X S&P 500 Covered Call UCITS ETF (XYLU LN) follows a synthetic strategy, in which the Fund seeks to replicate a buy-write index by selling covered calls, with underlying equity exposure designed to match constituents of the S&P 500.
The S&P 500 is a market-capitalisation weighted index of 500 leading publicly traded companies in the US. The S&P 500 is regarded as the best gauge of the US large cap equity market. The index has often become a preferred choice for investors to express US equity market views given its diversified sector exposures and large cap tilt. The increasing popularity over the years of companies in various sectors such as Apple, Microsoft and Amazon has also led investors to gravitate towards the S&P 500 as market valuations of those companies increased.
The Global X Nasdaq 100 Covered Call UCITS ETF (QYLD LN) follows a synthetic strategy, in which the fund seeks to replicate a buy-write index by selling covered calls, with underlying equity exposure designed to match constituents of the Nasdaq 100.
The Nasdaq 100 consists of the top 100 non-financial companies listed on the Nasdaq exchange, forming a portfolio primarily focused on high-growth sectors like information technology, consumer discretionary, and communication services. Over time, this composition has proven advantageous for the index, benefitting from the strong performance of these growth-oriented sectors. This has led to an increase in popularity due in part to its exposure to well-known, mega-cap companies that can be found within the aforementioned sectors such as Meta, Apple, Amazon, Netflix, Alphabet and Microsoft. Known as “MAANG+M”, these companies combined make up 39.9% of the Nasdaq 100 index, as of 31 October 2022.
Monthly distributions (distributing share classes only) for both strategies are capped at half of premiums received or 1% the of fund’s NAV; with any excess premiums reinvested into the fund. When adding to a portfolio, covered call strategies could be considered as a partial replacement to equity and fixed income as the yield on these strategies is typically higher than fixed income alternatives. Covered call strategies can come with higher volatility than fixed income but can have lower volatility than the underlying stocks in the reference index tracked.
Covered call strategies, such as the Global X S&P 500 Covered Call UCITS ETF (XYLU LN) and Global X Nasdaq 100 Covered Call UCITS ETF (QYLD LN), could be valuable in an uncertain market environment for the European markets. Higher volatility tends to increase the options premiums received from writing covered calls, which can enhance returns even in a trendless market. Moreover, the income from index-focused covered call strategies can help diversify an income portfolio away from traditional sources such as dividend-paying stocks or fixed income investments.
Explore more about our covered call strategies here.
Rohan Reddy is director of research at Global X
Capital at risk: The value of an investment in ETFs may go down as well as up and past performance is not a reliable indicator of future performance.
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