Market Overview

Income and Appreciation with Covered Calls

Income and Appreciation with Covered Calls

A strategy that involves exposure to the stock market, as well as generating monthly income, sounds like a great option in the current market environment. The covered call strategy, also referred to as a buy-write strategy, involves buying shares of a stock and selling a call option against the position.

It can be used to lower volatility and generate income while at the same time keeping exposure to the stock market. There is a downside risk to the strategy, that involves a strong bull market. If the stock moves above the strike price on the call option that was sold against the stock, it will limit the upside potential of the stock. In essence, an investor is putting a limit on the gains in exchange for monthly income from the option premiums.

In the situation where the strategy takes too much time or is too complex for the individual investor, there are ETFs that focus on the covered call strategy:

PowerShares S&P 500 BuyWrite (NYSE: PBP). This ETF is based on the CBOE S&P 500 BuyWrite Index that holds a portfolio of stocks that tracks the S&P 500 and sells call options at or above the prevailing price of the index. The current yield on the ETF is 6.5 percent and it is up 5.9 percent this year. A recent rally has the ETF trading at the best level since June, as interest rates have once again started to increase. As interest rates rise it makes the income generated by the covered calls more attractive. The expense ratio is 0.75 percent.

iPath CBOE S&P 500 BuyWrite Index ETN (NYSE: BWV). This ETN tracks the same index as PBP with one major difference -- being how they achieve their objective. With an ETN, the product will use various financial vehicles to track an index, versus actually owning the stocks that make up the index. Therefore the risk lies on the issuer of the ETN, in this case Barclays (NYSE: BCS). The expense ratio is 0.75 percent and the ETN is up 11.3 percent in 2013. There are no distributions made by the ETN.

Horizons S&P 500 Covered Call ETF (NYSE: HSPX). Introduced in late June of this year, HSPX will track the same index as the first two covered call ETFs. The expense ratio will be slightly lower at 0.65 percent. The dividends are paid on a monthly basis, versus quarterly for PBP. Based on the erratic first four months of dividends the ETF is yield just under 4 percent. This yield is expected to vary greatly from month to month.

AdvisorShares STAR Global Buy-Write ETF (NYSE: VEGA). The actively managed ETF uses a proprietary strategy, that invests in a global allocation strategy and simultaneously sells call options against them. So far this year the ETF has been lagging the market as it is currently unchanged in 2013. Based on last year's one distribution the ETF is yielding less than one percent -- and on top of the 2.1 percent net expense ratio there is no reason to look any further into this vehicle.

Of the four options, three are tracking the same index -- and the two that appear to be the best options for investors are PBP and the newly introduced HSPX.    


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