ETFs
Why Canadian Investors Are Turning to High Yield Covered Call ETFs for Cash Flow
Over the years, Canadian investors have increasingly adopted exchange-traded funds (ETFs) to deal with stock market volatility, rising costs of living and retirement plans. When last checked in the second half of 2023, covered call ETFs were the third most popular ETF category in Canada this year, according to TD Securities data, attracting $3 billion in new assets.
The primary reason for this trend is that covered call ETFs, such as those offered by BMO Global Asset Management, allow investors to generate additional cash flow through option premiums while carefully managing risk. Essentially, investors are able to increase their cash flow and mitigate the volatility of their stock portfolio by capitalizing on a popular options strategy that traditionally requires a high level of technical expertise to implement.
Understanding Covered Calls
A covered call is an investment strategy in which an investor owns a stock and sells a call option on the same stock. This approach is ideal for markets with minimal price fluctuations. It provides coverage against minor losses and a method of generating cash flow by collecting option premiums. However, while covered calls can secure cash flow and mitigate volatility, they cap gains on the short portion of the portfolio if the stock price rises above the call option’s strike price. purchase. Nonetheless, the benefits of covered calls have attracted growing interest from investors, particularly in the form of covered call ETFs.
Covered call ETFs provide a simpler way to implement covered calls and have gained attention for their ease of use without sacrificing the benefits of the covered call strategy, namely cash flow and reducing portfolio risk. In fact, they can be an attractive alternative for investors, who can implement this strategy themselves due to the efficient trading, professional management and low management expense ratios of an ETF. For many investors, covered calls are difficult to implement and manage, and these ETFs provide convenience in managing the call writing process for investors.
BMO: Largest Provider of Covered Call ETFs
BMO is recognized as the largest provider of Covered Call ETFs, with a diverse range of funds that cover various strategies, regions, countries and sectors. Since launching its first covered call ETF in 2011, BMO has focused on improving revenue and managing risk through market cycles. ETFs, such as BMO Canadian High Dividend Covered Call ETF (TSX:ZWC) and the BMO Technology Covered Call ETF (TSX:ZWT), aim to strike a balance between generating cash flow and participating in rising markets by writing call options on approximately half of the securities in the portfolio and using a dynamic option writing strategy.
What’s important for investors to understand, with the influx of new products hitting the market, is that not all covered call ETFs are created equal. Seemingly small differences in methodology can make big differences in the bottom line. It is important to understand the methodology used by the ETF provider to generate additional cash flow, as this can help or hinder finding the right balance between desired cash flow and necessary long-term growth. How much of the portfolio is written, whether the options are in-the-money or out-of-the-money, and the duration of the options will all impact the performance of the strategy.
Benefits of choosing BMO Covered Call ETFs
Investors in BMO Covered Call ETFs enjoy several benefits:
- Higher yield: Premiums from written call options provide additional yield, thereby improving overall investment returns.
- Risk reduction: Covered call strategies inherently reduce risk by providing income that can offset potential losses on the underlying stock positions.
- Tax efficiency: Premiums earned on call options are generally taxed as capital gains, making them an attractive option for tax-sensitive investors.
- Lower volatility: Historically, covered call strategies have been shown to provide similar exposure to the underlying assets but with reduced volatility.
- Experienced management: The BMO ETF team brings extensive experience in portfolio management and derivatives trading.
That being said, while covered call ETFs have many benefits, the tradeoffs need to be examined. The main concern raised is the trade-off between cash flow and growth, the possibility of missing out on significant gains if the stock price rises above the strike price of the call option. Investors should also understand the complexities of options trading and the specific strategies used in the ETFs in which they invest. Choose an ETF provider that offers full transparency about its strategy, including factors such as how much of the portfolio it writes to, whether options are at-the-money or out-of-the-money, and time to maturity options can help you determine how much upside potential you could give up in exchange for this increased level of cash flow.
Canadians take note
Covered call ETFs represent a strategic option for Canadian investors looking to improve cash flow and manage investment risks in a challenging economic environment. BMO’s line of covered call ETFs offers a professional and diversified approach to using this strategy, making it accessible to a wide range of investors. For those considering this investment, a thorough review of the fund’s prospectus and consultation with financial advisors is recommended to fully understand the potential rewards and trade-offs. To find out more, click here.
Featured photo by Hunter Race on Unsplash.
This article contains sponsored content. This content is for informational purposes only and is not intended to constitute investment advice.
Commissions, management fees and expenses may all be associated with investing in exchange-traded funds. Please read the ETF Facts or the BMO ETF Prospectus before investing. Exchange-traded funds are not guaranteed, their values change frequently and past performance may not be repeated. For a summary of the risks of investing in BMO ETFs, please see the specific risks discussed in the BMO ETF prospectus. BMO ETFs trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.
BMO ETFs are managed by BMO Asset Management Inc., which is an investment fund manager and portfolio manager, and a separate legal entity from Bank of Montreal.
This article is for informational purposes. The information contained herein does not constitute and should not be construed as investment, tax or legal advice to any person. Particular investments and/or trading strategies should be evaluated against the individual’s investment objectives and professional advice should be obtained in all circumstances. “BMO (M-bar roundel symbol)” is a registered trademark of Bank of Montreal, used under license.
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