Covered Call Funds: Here’s How They Work

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Lined name methods provide an interesting technique to enhance your funding earnings and shield towards market downturns. Whereas this technique might be difficult to execute by yourself, exchange-traded funds (ETFs) make it easier for traders to undertake a lined name strategy.

Right here’s what you might want to know earlier than shopping for a lined name ETF, together with a few of the potential drawbacks.

What’s a lined name fund and the way do they work?

A lined name fund is an funding automobile that generates earnings for fundholders by promoting name choices on the shares of their portfolio.

For instance, a lined name technique could contain promoting a name possibility with a strike worth above the present market worth of a inventory, like Apple (AAPL), and receiving an upfront cost that generates earnings for fundholders.

If the worth of Apple declines, the fund’s draw back is considerably protected as a result of it acquired the premium cost for promoting the decision possibility. The bought name will expire nugatory, and the fund will proceed to carry the shares.

Nevertheless, if Apple shares rise above the strike worth of the decision possibility bought, the decision purchaser could train their possibility and “name” the shares away from the fund. On this case, the fund gained’t expertise the total appreciation of the inventory due to the bought name.

When is an effective time to purchase lined name funds?

Lined name methods are likely to carry out the most effective when markets don’t transfer a lot in both path. A secure or sideways market permits your holdings’ worth to stay pretty fixed whilst you earn earnings from promoting name choices.

Nevertheless, if the market strikes strongly to the upside, the decision choices you bought will doubtless be exercised, inflicting you to overlook out on the potential features. If markets drop considerably, the earnings you earned from promoting choices will provide some safety, however gained’t solely protect you from losses.

As an illustration, in 2022, the S&P 500 Index, together with dividends, fell 18.1 %, whereas the International X S&P 500 Lined Name ETF (XYLD), which writes calls on the index, fell by 12.1 %. In 2024, the S&P 500 rose by about 25 %, in comparison with a 19 % enhance for the lined name ETF.

Dangers of lined name funds

Lined name funds carry dangers that traders ought to concentrate on.

• Missed features: In a powerful market, lined name funds could not totally understand the potential features of their shares since they’ll get referred to as away by whoever purchased the decision choices.
• Decline in holdings: It’s necessary to do not forget that the worth of lined name funds should still decline if their holdings lose worth, however the decline will likely be lessened by the earnings generated from writing calls.
• Fund charges: Buyers ought to regulate the charges charged by lined name ETFs as they usually have increased expense ratios, or charges, when in comparison with these of a standard index fund.
• Tax Implications: Earnings earned from a lined name fund held in a taxable account, akin to a brokerage account, will likely be taxed at bizarre earnings charges. Buyers can keep away from this tax legal responsibility by holding the funds in a tax-advantaged account, akin to an IRA.

Lined name ETFs to think about including to your portfolio

(Be aware: Info correct as of Feb. 4, 2025.)

For those who’re fascinated by exploring lined name ETFs, listed here are a number of choices to think about:

International X S&P 500 Lined Name ETF (XYLD)

This ETF invests in S&P 500 firms whereas additionally promoting calls on the index. As of February 2025, it held roughly $3.2 billion in belongings.

12-month yield: 11.6 %
1-year return: 19.3 %
Expense ratio: 0.60 %

JPMorgan Fairness Premium Earnings ETF (JEPI)

This fund holds about 115 shares and generates earnings by promoting out-of-the-money S&P 500 name choices. Its prime holdings embody Meta Platforms (META), Amazon (AMZN), Mastercard (MA) and Visa (V).

12-month yield: 7.2 %
1-year return: 12.3 %
Expense ratio: 0.35 %

International X Nasdaq 100 Lined Name ETF (QYLD)

This ETF holds firms within the Nasdaq 100 index and sells calls on the identical index to generate earnings. The fund held roughly $8.8 billion in belongings as of February 2025.

12-month yield: 12.4 %
1-year return: 18.3 %
Expense ratio: 0.61 %

International X Russell 2000 Lined Name ETF (RYLD)

This fund focuses on small-cap firms by proudly owning shares within the Russell 2000 index and promoting calls on the index. It additionally makes use of a Vanguard ETF to realize publicity to the index. The fund held $1.5 billion in belongings as of February 2025.

12-month yield: 11.9 %
1-year return: 14.3 %
Expense ratio: 0.60 %

Backside line

Lined name ETFs could be a technique to generate extra earnings out of your investments, however they need to be used as a part of a diversified portfolio. You should definitely perceive how a lined name technique works earlier than investing and be careful for fund charges, which might eat into your general returns. For those who’re seeking to increase the earnings generated out of your portfolio, you may also contemplate excessive dividend shares.

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Editorial Disclaimer: All traders are suggested to conduct their very own unbiased analysis into funding methods earlier than investing resolution. As well as, traders are suggested that previous funding product efficiency is not any assure of future worth appreciation.