Income Innovations: Single Stock Covered Call ETF

Active ETFs have not only brought the benefits of low-cost active management to the investment party, they’ve also allowed investors to tap into some strategies not available in a passive form. One of these just happens to be options strategies, with covered calls leading the way. This fact has quickly made the JPMorgan Equity Premium Income ETF (JEPI) a runaway hit with nearly $29 billion in assets.

But the covered-call options overlay revolution is just getting started.

Thanks to a series of new launches from Elevate Shares, investors have the opportunity to use options on single stocks. To that end, they could potentially generate yields as high as an eye-popping 52%. While that yield is risky, it does underscore the innovation happening in the active ETF space.

Covered Call ETFs in a Nutshell

Options have a connotation of being risky or returns-seeking. Visions of sophisticated traders with multi-screen monitors come to mind. However, that couldn’t be further from the truth. Yes, there are some risky options strategies, but what investors are doing with options is basically hedging their positions. Options give investors the right, not the obligation—that’s a futures contract—to purchase or sell an asset at a certain price at a certain time.

A covered call or a buy-write is one of the simplest options strategies to use. Here, an investor buys a stock or a basket of stocks tied to an index and writes call options that cover the position. The option writer collects a fee for agreeing to the transaction, which they keep no matter what. At the same time, they hold the stock and collect the dividends it generates until such time as the option is exercised. If it expires and is never used, the option writer gets to keep the shares. Rinse & repeat.

The key is that in sideways or down-trending markets like this, most options tend to expire worthless, and covered calls can be used to generate additional income on a portfolio. This helps explain why covered call ETFs like JPEI or Global X NASDAQ 100 Covered Call ETF (QYLD) have gathered billions in assets. Stocks have been roughly flat or down trending and covered calls are a smart way to generate some real returns from an equity sleeve.

The key is that active management makes a serious difference in both yield generation and returns. Passive covered-call ETFs like the Invesco S&P 500 BuyWrite ETF (PBP) have been on the market for quite a while, with PBP launching back in 2007. PBP yields just 1.65%, while actively managed JEPI yields north of 8%.

The Next Evolution of Covered Call ETFs

One of the benefits of the ETF revolution—passive or active—has been the ability to lower costs. Not just in expense ratios, but in the overall cost of physically investing in asset classes. Owning commodities via futures requires collateral. Buying individual bonds comes with wide bid/ask spreads and knowledge of over-the-counter (OTC) markets. Or you can just buy an ETF. The same can be said for covered call and option writing.

To that end, Elevate Shares through its YieldMax line-up of ETFs has started to roll out and develop ETFs that focus on single stock covered-call strategies. The difference is that JEPI and the other popular covered-call ETFS write their calls against entire indexes like the S&P 500. This is the first time for single stock exposure via covered calls.

Suppose you own shares of Tesla and you’d like to hedge your position or generate some income from your shares. TSLA doesn’t pay a dividend, so the only way to do that is to write covered calls. Aside from being approved for options trading in the first place, the issue is that to write a covered call, you need to own at least 100 shares and an additional 100 for each additional option you’d like to write. With a price tag of $275 per share at the time of writing, that might be out of the question for many shareholders. At the same time, the option premium for one call is usually around $1 or less. Option income is a game of scale.

Or you could buy the YieldMax TSLA Option Income Strategy ETF (TSLY).

Actively managed by ZEGA Financial, the new ETF uses a mix of long call and long put options on the underlying single stock—in this case TSLA—and then sells one-month call options on the underlying stock with strike prices between 5% and 15% above that stock’s current share price.

With Elevate’s ETFs, the cost headaches and initial investment requirements are no longer an issue. The average retail investor can now use options to hedge their positions. Moreover, the income potential is massive. Including generated option income, the Tesla fund features a massive 52% distribution yield. For the YieldMax AAPL Option Income Strategy ETF (APLY) —which follows the same strategy for Apple—is a more reasonable 15%.

All in all, YieldMax now offers 15 ETFs that cover various single stocks with calls including PayPal, Amazon, Exxon, and even Coinbase, with another four in registration. Not to be outdone, issuer Rex has filed its own suite of actively managed ETFs that will also write covered calls on single stocks, as well as several ETFs that do so on other popular passive ETFs like the iShares Emerging Markets ETF (EEM).

Using the ETFs

The use case for the new ETFs is intriguing. Many of the ETFs in YieldMax’s suite are uber-popular tech stocks with a hefty dose of volatility. At the same time, many don’t pay a dividend or perhaps pay a very low one. For investors looking to hedge these positions and generate a little extra cash from owning them, a covered-call strategy is a pretty good and safe one.

With the new ETFs, this makes the process very easy to do.

Now, the caveat is to remember that some of the yields on these products will not stay that high. That yield depends on market conditions and they will change. For example, kingpin JEPI is only paying 8% these days, whereas a year ago it was paying north of 12%. Moreover, if stocks start to surge, covered-call strategies lag the overall market as upside is capped because of the call option. It’ll get called away.

But with that in mind, they could find a way into many investors’ portfolios.

Covered-Call ETFs

These funds were selected based on their YTD total return, which range from 1% to 24%. They have expenses between 0.35% to 0.60% and have assets under management between $90 million to $30 billion. Their distribution yield range between 1% and 12%.

YieldMax Single Stock Option ETFs

Since these funds were launched within the last year, most of them do not have YTD return data for comparison. They have been arranged in descending order of their yields, which range from 0% to 53%. All of them have an expense ratio of 0.99%, with AUM between $2 million to $600 million.

Ultimately, the YieldMax funds are a good example of how ETFs continue to change the game for investors, allowing them access to asset classes and strategies once reserved for institutional investors.

The Bottom Line

Covered-call ETFs have taken the world by storm and now investors have the option to use options on single stocks. The YieldMax line-up of funds allows portfolios to hedge single positions and generate plenty of option income.