Should I invest in high yield covered call ETFs?

Why is dividend investing an attractive investing strategy? The main attraction, I think, lies in the idea of living off dividends, being tax-efficient, and not touching your principal. By not touching the principal, many investors believe dividend investing provides more margin of safety and allows them to sleep better at night. 

This is valid logic but one must also consider geographical and asset diversification. This is one of the key reasons why we invest in index ETFs like the iShares ex-Canada ETF, XAW. But that’s another topic for another day…

Recently a reader asked whether we invest in high yield covered call ETFs. Given that many of these covered call ETFs have very high yields, the reader wondered why we don’t use them to increase our dividend income and expedite our financial independence journey.

Should we invest in covered call ETFs? 

Higher dividend = higher risk

One important thing to know is that you cannot arbitrarily increase yields without taking on additional risks. In order to pay dividends to shareholders, companies must have the money. If a stock has a very high yield, it typically means the company passes most of its earnings to shareholders rather than retaining and reinvesting the earnings into the company for further growth. 

Interestingly, if you look at the details of the high-yield covered call ETFs, most of them use keywords like “high quality,” “mitigating downside risk,” “attractive monthly distributions,” “total return,” etc. It is almost as if these covered call ETFs are extremely safe and the high yields do not add more risks. 

Is this true? 

Before I dive into that question, let’s go over some terms for options trading.

Options 101 – What is a covered call?

In options trading, there are two things an investor can do – put and call. 

Put Options

A put option is a contract that gives the buyer the right, but not the obligation, to sell a specific amount of an underlying security at a pre-determined price (strike price) within a specified time frame (expiration date). 

Put option buyers profit when the security price falls below the strike price and before the option expires. 

Put option sellers collect a premium upfront. The ideal situation for a put option seller is that the security price will stay flat or rise above the strike price before the expiration date, making the put option worthless.

To learn more about put options, check out this article by Bankrate.

Call Options

A call option is a contract that gives the buyer the right, but not the obligation, to buy a specific amount of an underlying security, like stock, ETFs, or commodities at a specific price within a specific time period. 

One would typically buy a call option when one believes the underlying security will increase in price before the option expiration date. 

A call seller makes money upfront by collecting a premium. If the security price stays flat or declines, the option contract expires and the call seller makes money from the option premium.

Since options simply give you the right to sell or buy a specific amount of asset within a designated time frame, you don’t necessarily need to own the underlying asset. Therefore, we also need to cover the terms “naked” and “covered.” Naked options mean that the investor does not own the underlying security, while covered options mean the investor already owns the underlying security. 

To learn more about call options, check out this article by Bankrate.

How to increase yield by using covered calls

When you sell a call option, you get paid a premium. On the day the contract expires, if the stock price is below the strike price, the contract expires and you not only pocket the premium, you also get to keep your shares. 

If the stock price is above the strike price, the call option buyer will exercise the option. When this happens, you are obligated to sell your shares to the buyer at the agreed strike price. 

For a covered call, since you already own the shares, you just sell the shares to the buyer and pocket the money. If it were a naked call, you’d have to buy the shares in the open market, typically at a higher price than the strike price, then sell the shares to the call buyer at the strike price. In other words, you will incur a loss (i.e. your “buy” price is higher than the “sell/strike” price). This is why selling covered calls are generally safer than naked calls. 

How do these ETFs increase yields by using covered calls? Well, they increase the distribution yields by selling covered calls, collecting the premiums, and distributing part of the premiums to shareholders.

Is it a win-win?

Because of its nature, covered calls tend to perform better in flat or down markets, because the call options typically won’t get exercised. However, when the market is hot or the stock price goes for a wild ride, covered calls will often get exercised, resulting in poor performance for cover call sellers. 

So, it is more effective to utilize covered call options when the market is not very volatile. 

Covered call ETFs typically already own a handful of stocks. The fund managers then sell covered call options to collect premiums. These premiums and the stock dividends are passed down to the shareholders, resulting in higher dividend yields. 

But don’t convince yourself that this is a win-win situation.

As mentioned, not every covered call option ends up expiring. Due to better than expected earnings or good news, the stock price can jump suddenly before the option expiration date. So, some options will get exercised and the fund managers will need to sell stock shares. 

When options are exercised, the fund company needs to declare capital gains or losses, resulting in tax consequences. The fund managers also need to buy back the stock shares to ensure the ETF meets the underlying equity holding percentages. 

For example, say the fund is maintaining a 5% exposure to Royal Bank and the fund just sold a considerable number of RY shares because call options were exercised. In this example, the fund managers need to buy more RY shares at market price to meet the 5% exposure. All this selling and buying means a higher management expense ratio (MER) – and thus money out of the investor’s pocket.

Furthermore, while the yields might look nice, it is highly likely that most of the yields come from capital gains (referred to as ‘return of capital.) Investors won’t be able to utilize the favourable dividend tax credits and may have to pay capital gain taxes on a portion of the distribution. If we look at the tax breakdown of ZWG, we’ll notice that in 2020, 28.28% of the distribution was from capital gains and 36.21% of the distribution was from the return of capital. Only 4.67% of the distribution was from eligible dividends. 

While dividend income is important, I believe dividend investors should care about the overall portfolio return, regardless of whether they plan to sell principal or not. The total return approach gives investors more flexibility because they can sell a small portion of their portfolio to supplement dividend income.

With the total return in mind, I am not convinced that the high yield covered call ETFs will perform better than low-cost passive index funds like VCN and VXC or dividend ETFs like VDY over the long term. Below is a comparison.

ETFMERYield3-Year Return5-Year Return

This is not a very scientific comparison but for these covered call ETFs, it appears that you may be trading a higher dividend yield for a lower total return.

To make things more confusing, rather than holding stocks directly and selling covered calls, some covered call ETFs hold a selection of various covered call ETFs. For example, Hamilton Enhanced Multi-Sector Covered Call ETF, HDIV, holds a mix of various covered call ETFs and income ETFs like NXF, FLI, ZWB, HTA, ZWU, HHL, and HEP. It is extremely difficult to understand the specific underlying securities HDIV holds. 

HDIV’s approach is very similar to the all-in-one ETFs and the all equity ETFs like VEQT, XEQT, and HGRO that Vanguard, iShares, and Horizons offer. The key difference? The likes of Vanguard, iShares, and Horizons construct these all in one and all equity ETFs by holding company-managed ETFs; HDIV uses non-Hamilton covered call ETFs. (Also, a major difference is that HDIV uses what they term a “modest leverage” of 25%.)

Should I invest in high yield covered call ETFs? 

We don’t own any high yield covered call ETFs, precisely because of what I have written. We prefer owning individual dividend paying stocks and low cost passive index ETFs to keep a simple dividend portfolio and build our dividend income accordingly. 

Does that mean you shouldn’t invest in covered call ETFs?

Well, it depends.

If you are close to retirement or already living off your portfolio, covered call ETFs might be an effective way to increase your overall investment income and not have to withdraw as much from your portfolio.

But if you are still in the accumulation phase, I believe you’re better off owning individual dividend stocks or index ETFs. If you decide to boost your investment income once you’re more experienced, you can always consider selling calls or puts and collecting dividends. Liquid from Freedom 35 started selling options and has done well. You may want to look at this guide if you want to explore earning options with dividend stocks.

I know many dividend growth investors sell covered calls or covered puts to increase their passive income. We haven’t done that because it becomes more speculating than investing. Furthermore, I don’t have time to do the research required to execute calls or puts. 

Please note, I’m not saying that you should just stay away from covered call ETFs. These covered call ETFs are created because there are demands. It is the same reason why preferred shares ETFs, split corp funds, or income trust funds were created. We shouldn’t just flat-out reject them and never consider investing in them. It is important to see them as yet another tool in your toolbox that you can use to construct your portfolio. 

Having said that, be careful with having a too high concentration of covered call ETFs, high yield low growth dividend stocks, income trusts, and split corp in your investment portfolio.

Remember, the higher the yield, the higher the risk. 

Manage your risk! 

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30 thoughts on “Should I invest in high yield covered call ETFs?”

  1. I am a fan of EIT.UN but at the right price. As mentioned in comments, you have to wait for it. I was holding it in the RESP account for a while. Now I am withdrawing for university. It’s to expensive now and also waiting for a drop. Once it does, i will pounce!

    I am not a fan of high yield covered calls. I prefer banks covered calls or utilities or other blue chip focus ETF. Basically, i contract out the covered call strategy as it is proven to lift income. Like Tawcan, i don’t have time to research options …

    I am testing (with real money) HCAL as a proxy to banks right now. Will see how that compares.

    I also believed covered call ETFs have a place if you shop properly when you are focusing on income. I have mostly covered call ETFs in the corporate account for income. Why leave cash sitting in the bank when you can earn 6% on it.

    Note that dividend investing doesn’t necessarily mean income investing for all people. There are many blended investing with dividend stocks.

  2. Hi Bob

    You always talk about accumulation phase, personally I feel there is no such thing and the reason are such.
    When you have an upturn in the market as you have had in the past 10 years, taking capital gains or losses every year is important because at the end of the day if you do not, you or your beneficiaries will be hit with one massive tax bill.
    My FA has seen new clients who have been investing for decades and have always DRIPed their stocks, through good times and through bad. We are talking about people who make upwards of $30k in dividends per quarter on various stocks and still DRIPed these dividends. The problem being, the shares they bought for $10 decades ago have now amassed invalue to the point where your ACB(average cost base) is scarey, aka $50/share, ACB now about $0.50 cents, so at the end of the day, every share you now sell leaves you with $49.50 in capital gains, that is scarey. Much better to stop the DRIP and invest the dividends elsewhere.
    Now back to accumulation phase, it does not exist, reason being, when markets go up, you should sell/buy to realize capital gains to bring your book value up and when markets go down you should also sell/buy to offset gains with capital losses. Anyone who holds stocks for years or decades just makes it easier for the CRA to realize a gain when you leave this place or when you think your accumualtion phase is over.
    The HARDEST thing to teach people after decades of investing, is actually to start spending and the sooner you get into this habit the better off you are.
    Having said this, I use covered call ETFs for this reason, when I sell for capital loss and want to rebuy the stock, where do I park my cash for easy gains at actually minimal risks in a downturn market? One of the covered call ETFs, even in a down market, they hold value much better than individual stocks at that time.

  3. Hi Bob

    You fail to see why some of us actually hold covered call ETFs.
    Most covered call ETFs payout on a monthly basis and it is a place to park cash for a short period of time and realize gains.
    Just as is the case with treasury bills as a form of short term investing.
    It comes down to realizing better returns then what your bank or brokerage firm would give you to have that cash idle. Are there risks, certainly, just like walking across the road to get your daily Starbucks.
    No risk, no reward.

    • Gerhard, I support your approach but there are advocates out there for utilizing covered call funds, split funds, and other high yield vehicles to fund retirement and even early FIRE.

      I think those people are taking a measure of risk that is very high.

      • See James, comes down to comfort levels.
        I personally have never and would never leverage myself to the point where I could not sleep at night. Having said that, there are people out there that would leverage themselves to the hilt, aka Nelson Skalbania from the 1980s. His former wife ended up with the Wedgewood hotel in downtown, one of the premier properties in Vancouver.
        I have and hold monthly closed call ETFs, and also hold money market currency exchange funds, for the simple reason, they pay monthly, and at the end of the day if they are down when I need the cash, I gain with a capital loss.
        On the US dollar side of my trades, gains are not considered capital gains, but losses I can write off as capital losses, all about having a good accountant that knows the tax system.
        Would also like to point out, and this is off topic rather something about ATTRIBUTION of stocks.
        Having used Ufile over the years and it is a program that was setup by the CRA, attribution rules do not apply, the program itself, will select the best way to allocate funds between your wife and yourself. Tried to split my T5 income and it kept giving it to me 100% because my write off was better and that from a program by the CRA.

    • Hi Gerhard,

      You’ll notice that at the end of the article I said whether one should invest in high yield covered call ETFs depends on your situation. If your aim is to get the monthly distributions and are OK with the risk, then by all means. Personal finance is personal.

  4. In June of 2019 they increased the distribution from $0.10 to $0.13. I think the possibility exists for another raise within 12 months but who knows.

  5. James R . This is interesting. Thanks very much. Have they increased Divs or decreased them over the last 5-8 years ? I noticed they have a 100 M in debt . Kind of odd, it must be from their Div’s ? They must do a cover call on at least 20% of holdings- I think your right.
    Thanks again, I’ll take a closer look…Over weekend.
    James V

  6. Thanks for the question, with EIT, you definitely have to buy it on dips. The dips will make up for capital appreciation and your inflation buffer. Buying it at the top of the market like we are, is fruitless. The distribution has not changed in quite some time. That can be good either way you look at it. So, it’s a function of where you buy it on the dip in the market. I will usually buy a full position and sell half of position, as of this week a matter of fact. I bought my full position back in May 2020,. We are hitting new highs every day so I suspect there will be a buying opportunity in the future. A market correction Has to happen just for the simple purpose of keeping the market healthy. If you look further it’s underlying securities are blue chip and very high-quality.

    With regard to your other question, JEPI , it is very very new, run by JP Morgan. Very good quality managers who run this ETF, probably some of the best in the USA. They have a policy of paying out a certain ratio with respect to their income to keep the ETF healthy. It is quite early to gauge the long-term performance, however the managers are very good quality … and overall much cheaper than EIT. One thing you have to look at as well is what percentage of the underlying currency is subject to cover calls? A conservative cover call ETF will have 10% to 20% exposed to covert calls. Some not so conservative can be as high as 60 to 70%.
    Sorry for any typos errors, voice to text while I’m hiking with the dogs on Vancouver Island hiking. 🙂 overall, you do give something up when you enter into a covered call ETF. Having a 10% sleeve of ETFs times right, can work out well for income. It certainly isn’t something like BC E, where that is more of a bond proxy with regular dividend increases. Covered call ETFs usually have a higher beta as well, so you can usually get them at a good price when markets turn south. I think we are due for a correction anytime. Thanks

    • Thanks for the detailed reply. I can see how trading in and out of EIT could work, but then you’re timing the market. Sounds like you’ve done well with it but I’m not sure that approach is for me. I think without evidence of historic dividend raises EIT, and funds like it, present a risk to long term buying power that still makes me uneasy.

      • Just back from the hike with the doggies ! 🙂 . You’re right , you basically have to be “…running into the burning building when people are running out!”. It takes a bit of courage to do that for sure. Just like buying Telus us when everybody is selling it…down market corrections or crashes are nasty – but profitable for a guy like me. Its much like fishing – soon or later you will get a bite/ correction , You just have to have your dry powder ready and not sitting idle doing nothing while you wait. It’s certainly not for everybody. Traditionally the more you trade, the more chance of losing capital is there. I don’t know how D traders can do it. TXF I bought in March of 2020, with a great yeild- it had all the big solid Blue Chip Tech’s in there. I have kept it , since it keeps climbing . Its on my chopping block soon though- at least 60-70% of it. I will keep the profits as ‘ dry powder ‘ for TD, KEY, MDT, OTIS, RTX and the like, when the “building is burning!” and the correction happens . I could never say a buy and hold strategy is wrong. With the majority of my portfolio I never buy a company with the intent of selling out in the short term. I always buy the company with at least a 5 to 10 year hold on 90% of my portfolio . BTW , Buffet is at the highest cash position he has ever been right now in November 2021 ….the same holds true for Prem Watsa right now . BX,(one of my favourite companies- been holding them for 15 years + when they were a LP , now a Corp. structure) has also built a huge cash position right now . Won’t be long … just a follower 🙂

        Whats your thoughts on AB -NYSE ? , just evaluating them for a downturn …

        Good luck with everything ,



        • I stick mostly with Canadian stocks (although a couple generate the majority or all of their revenue in the States).

          I meant to come back here and mention that there is one “alternative” investment that I’m quite pleased with and that is ENS.TO – E split corporation – the A class shares.

          For those who are unfamiliar E Split Corp, it is a split share fund that only invests in Enbridge. For YTD 2021 they have beat the return of Enbridge by over 14%. I believe they also use a covered call strategy. They pay a monthly dividend, and have a DRIP discount (when the unit price is above the NAV). So, for me the ability to DRIP / compound monthly is a huge advantage.

          This is not for everyone, just like covered call ETFs are not for everyone, but I’m a huge fan as they have done an excellent job.

          One note, the distributions are (about) 67% eligible dividends and 33% return of capital so there are some tax consequences to be aware of if held in a non-registered account.

  7. Great article. Thanks ! I use some cover-call ETF’s like EIT.UN and a few BMO or Harvest product to put in a “sleeve” of higher paying equities . Some of my high growth solid Blue Chip selections simply down pay enough to get me to my 5.5% total yield target …. So I use a mix of EIT.UN, Harvest, BMO and JEPI, and NUSI . Seems to work so far without taking on too much risk and Beta in 90% of the portfolio . Safe roads ahead , James

    • (From one James to another…..)

      I’m curious how you view EIT.UN in particular with respect to inflation. My big problem with the Canoe fund is they haven’t raised the distribution in the last 10 years (the chart I’m looking at only goes back 10 years). So, the $0.10 dividend in 2021 isn’t worth nearly as much as it was in 2011. How do you compensate for this? Plus, the 10 year chart on EIT.UN is a little disconcerting, other than the recovery from the COVID dip, which is pretty impressive.

      Similarly, with JEPI, the distribution is all over the place, but trending down. So, I’m curious how you expect to keep your income tracking along with inflation so that your spending power doesn’t take a hit over time.

  8. Covered call ETFs trade total returns for income, that’s for sure. However it is not accurate to say that they are riskier than non-covered call ETFs, even if their yield is higher. Actually they are less risky than holding the equivalent non-covered Call ETFs. This is because the enhanced income will “smooth” the ride, compensating drawdows with the additional income but also lagging on the upside as stocks get called.

    One very good way to prove this is to compare the two BMO canadian banks ETF : ZEB (non covered call equal weight canadian banks), and ZWB (covered-call equal weight canadian banks). These two funds are identical (equal weight top 6 CAN banks). As per the Morningstar ETF risk page on these two funds:

    ZWB: 3 years standard deviation: 18.03. Risk vs. category: Below Average. Return vs. category: Below average.
    ZEB: years standard deviation:19.76. Risk vs. category: Average. Return vs. category: Above Average

    So a higher yield does not automatically translate to higher risk, in the case of covered call ETF it is actually the opposite. However the downside of the lesser risk is the lesser return.. More risk, more returns! As a final note, the non-covered call ETF ZEB has better risk-adjusted returns (such as Sharpe ratio) than ZWB.
    ZEB: 3 years return: 15.53% annualized with dividends reinvested
    ZWB: 3 years return: 12.13% annualized with dividends reinvested

    For income-focused investors, covered call ETF are absolutely a worthwhile investment, keeping in mind that the total returns will usually lag the market but offering a somewhat smoother ride.

  9. I like to add an addition point although quite obvious. Unlike an index or sector ETF (say passive one) where the fund follows an index, this may not be the case with covered call ETF.
    So two things to look for in fund selection would be
    1) Quality of stocks or companies in portfolio should be excellent overall
    2) The fund’s or fund manager’s ability to find opportunities and write calls would decide the performance of the fund
    So the investor also bets or hopes the fund manager is skillful to find and execute such opportunities.
    So in this case one is not really investing in a pure passive fund (some exceptions may exist), but rather a quality dividend fund with call writing capabilities. A fund with blue chip stocks with call writing option income is a good tool in the box. Probably a great tool for someone who understands options but cannot write options by himself/herself due to higher capital and transactions cost requirements.

  10. Great summary! An upward market it is not all bad. Yes they are powerhouses in downward or flat markets and mediocre in upwards markets but you are really just trading the potential unlimited upside for limited downside (unless you used leverage).

    Also on the down side market the same rule to maintain weighting is in place so often that premium from the sale of the call increases # of shares which increases future premiums.

    You summed it up nicely that it is another tool in the box that needs to be used at the appropriate time. If you understand how the ETF works you should know enough to just sell the calls yourself and keep the money so I see the MER as a convenience fee at that point.

  11. Well said, Bob. I have come to the same conclusion that it is not for me, lol. But for someone who’s already retired, it could be a valid tool to add some covered call ETFs in their tax advantaged account. Personally I don’t like the part about buying back the stock at market value. I prefer to sell covered calls on individual stocks and buy back the ones that get called away when prices have fallen.

    • It makes sense to use it as a tool to boost income but it’s not for everyone. If you are a more advanced investor like yourself, it makes more sense to sell covered calls on individual stocks yourself.

  12. An easy one to compare is ZEB with ZWB who is ZEB with covered call
    You will make more money with ZEB (MER is lower) , IMO you make money with covered call if the stock move a lot (pharma ?) often because the premium is high but with normal stock like BCE BMO etc it’s hard to make money..

  13. When I first came across the high dividend covered call ETF it looked like a typical dividend index ETF with additional yield on top due to option writing income. As observed by bloggers and investment experts coverdd call etf yield usually performs well in flat or down-trending markets. I dont susbscribe fully to this idea of additional yield, but it does make sense as a good tool to navigate flat markets when capital appreciation is minimal or zero provided investor understands options to some extent and can afford to pay fees during underperformance periods.

    The BMO ZWC ETF is one example I came across. From what I understand they have portfolio of high-dividend stocks and write calls on up to 50% of holdings so in rising stock markets the holdings dont get exercised or sold off due to call exercise. In any case the bet/strategy is to have blue chips stocks generating dividend and write calls as additional income (icing on cake), and when call gets exercise due to spike in stock price you get capital gain or profit too. All good up to now. However when markets tank and there is capitulation like in early to mid 2020 you lose stock value or NAV and call writing income would not move the needle.
    So this strategy or ETF is not perfect and not bad either, but only suitable for some investors who have conviction in those stocks and option writing income. Personally I’m not interested in this product or ETF at the moment because in my opinion I’d prefer an index ETF such as XEI that can give decent dividend yield plus capital appreciation, whereas covered call ETF capital safety may not be that great. Also dividend ETFs appreciate in value overtime although modest and dividends grow with index gradually.

  14. Bob, I am 76 and willing to “risk” $6000 only on a covered call ETF of Canadian Blue Chips: BMO Canadian High Dividend Covered Call ETF. My reason is precisely because I get a monthly dividend, not much, of about $37, plus I like having a stake in Canadian stocks that I do not hold otherwise. I like the little dividend every month, and it comes from probably my riskiest investment, and at my age, my investments are very conservative. I will not invest any more in a covered call ETF, but enjoy this one for the above reasons. Love your communications.

  15. Hi Bob,

    I think your conclusion is spot on. While I wrap up my accumulation phase – with the expectation to retire in about 5-6 years I will avoid the covered call “flavour” of investments. But, once I get there I may very well choose some of these to boost my dividend income.

    To me, the bigger risk is the limited increase in dividends over time – one has to be careful that they’re not opting in for high income now, but giving up some inflation protection. I’d have a hard time going “all-in” with these, but to get my yield up around 6% overall I might consider it.

    By the way, I don’t think HDIV is that hard to understand. Each of the underlying ETFs is very clear about their holdings – and they are, for the most part, solid blue chip companies that many of us here would choose to own on their own. The risk, as you point out, is the when the strike price of the calls is in the money and the fund owners are forced to replace stock they have optioned away with stock at a higher price.


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