What Are Covered Call ETFs?

We excluded perennial number one and two — the SPDR S&P 500 ETF (SPY) and the Invesco QQQ ETF (QQQ) — from today’s Trackstar top five to make room for number three, the JPMorgan Equity Premium Income ETF (JEPI). 

JEPI is a covered call ETF. 

And it’s definitely the most popular. However, it’s not the only covered call ETF out there. Others include the Global X NASDAQ 100 Covered Call ETF (QYLD) with more than $8 billion in assets under management (AUM) and a nice expense ratio of 0.61% and the Global X S&P 500 Covered Call ETF (XYLD) with just under $3 billion in AUM and an expense ratio of 0.60%. 

By comparison, JEPI has approximately $32.8 billion in AUM and an even more attractive expense ratio of 0.35%. 

In today’s Juice, we’re not here to recommend these or any other covered call ETFs. Instead, we’re taking the opportunity to provide the basics on what covered call ETFs are, using these funds to illustrate. 

There has been a fair bit of hype surrounding covered call ETFs over the last year with much of it focused on JEPI. And, given how much we discuss generating income via your investments for your present or future needs, we figured a quick primer on the funds makes sense. 

So …

What exactly is a covered call ETF? 

First, it helps to know what a covered call is. 

In their simplest terms, covered calls inside ETFs work the same way they do inside your portfolio. The ETF writes covered calls against its positions, generating income from the call premiums it collects. Of course, this sets a limit on upside in these underlying holdings, but acts as insurance for the fund while generating income for investors. 

JEPI writes “out-of-the-money S&P 500 Index call options to generate distributable monthly income.” 

JEPI’s holdings include many of the stocks you’d expect from the S&P 500, led by Meta Platforms (META) and Amazon.com (AMZN). But, at portfolio concentrations of 1.76% and 1.73%, respectively, JEPI is not heavily overweight any one or set of companies like many other ETFs, particularly ones that use tech-heavy indexes. 

As for the covered calls, JEPI doesn’t execute the strategy the same way as you and I do. According to Morningstar, JEPI “packages its covered-call positions into equity-linked notes, a contract with the ELN issuer that mimics the payoff profile of a covered-call position.” This results in the option premiums being treated like interest income and, subsequently, getting taxed by the IRS as ordinary income. 

QYLD, the Global X NASDAQ 100 Covered Call ETF, writes covered calls against the Nasdaq 100 index. If you look at QYLD’s holdings, you’ll see a larger concentration of tech at the top, with Microsoft (MSFT), Apple (AAPL), Nvidia (NVDA), Amazon.com, Meta, Broadcom (AVGO) and Tesla (TSLA), the top seven positions, making up just over 41% of the portfolio. As of this week, QYLD is short the Nasdaq call option (short in that the fund sold/wrote the call) with a strike price of 17,750 and expiration date of March 15, 2024. The fund looks to mirror the performance of the Cboe Nasdaq-100 BuyWrite V2 Index.

XYLD, the Global X S&P 500 Covered Call ETF, does the same thing with a similar concentration of stocks at the top, but, as of this writing, a short (covered call) position in the S&P 500 Call Option with a strike price of 5,020 and expiration date of March 15, 2024. 

The Bottom Line: Here again, today’s Juice was meant to provide a succinct overview of covered calls ETFs. Conduct your own further due diligence to see if they make sense for you. 

That said, one general rule of thumb is that, with many of these ETFs, you’re generating significant monthly income at the expense of long-term upside in the underlying stocks. For example, QYLD yields more than 12%, XYLD roughly 10% and JEPI nearly 9%. These ETFs pay out monthly so you’re definitely getting consistent income if you go this route. 

Of course, as noted, you’ll likely pay taxes on this income. In tomorrow’s Juice, we broaden the scope and detail how taxes work with dividend stocks.

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