You’ve probably heard of exchange-traded funds (ETFs) — an investment product that holds a basket of assets that is traded on the stock exchange like an individual stock. You can buy or sell shares of an ETF through a stockbroker at market-driven prices. 

But what if you could go one step further and generate income through ETFs? Covered Call ETFs make that happen.

Not sure where to begin? We’ve got you covered. Here’s a short guide explaining what covered call ETFs are, their pros, cons, and how you can get started:

What is a Covered Call ETF

A covered call ETF is an exchange-traded fund that generates income by selling options on a certain number of stocks in an investment portfolio. Like traditional ETFs, it holds a basket of underlying assets but simultaneously “writes” call options on some or all of the stocks in exchange for a premium. 

How Covered Call ETFs Work

Let’s understand what is a covered call ETF with an example: Imagine you have an ETF portfolio with 100 shares. To generate income, you can write call options on a certain number of shares, such as 20. As the owner of the portfolio, you can sell a buyer the option to purchase those 20 shares at a predetermined price in the future. 

To secure the deal, the buyer will pay you a premium. This forms part of the income you get from a covered call ETF. Remember that this contract gives the buyer the right, but not the obligation, to buy shares on a specified date (called the expiration date).

If, by the expiration date, the set price of the share has risen, the buyer may exercise their right. But if the stock price falls below the set price, the buyer will not exercise their option. As a result, you will get to keep both the premium and the share. And that makes the second form of income.

Pros of Covered Call ETFs

Covered call strategies were once reserved for highly sophisticated options traders. But the modern-day trading world has made covered call ETFs super accessible. Here are some pros you should know:

Potential for higher income

If the price of a stock stays flat till the specified time, the portfolio owner has a great chance of earning higher returns. Moreover, the premium collected can enhance the total return of an investment portfolio. 

Convenience and Stability

ETFs provide an easy way to implement a covered call strategy. Investors don’t have to manually trade options on individual stocks, which reduces the complexity of the process. 

Guarding against volatility

Covered call ETFs offer protection against market volatility. Even if the share price increases, the premium from the buyer can help offset some of the losses. Overall, you can expect a steady income. Check out SoFi’s options trading platform to get started. 

Reasons to Not Buy Covered Call ETFs

Before you reach out to your stockbroker, learn some of the disadvantages of covered call ETFs. This includes:

• Capped gains if the share prices fall dramatically
• Underperformance in bullish markets
• Tax implications