Covered Call ETF’s are fairly simple but in order to help you understand, I will start from the veery beginning. Imagine owning stock on a company like Microsoft. Suppose you own 100 stocks. What would be your profits on this investment? It would be:

100 x (Current Price – Purchase Price) + dividend income

Simple enough right? Every day, your profits and income would change depending on the price of the stock and any dividends paid out on that day. Excluding the dividend, this is what the value of your investment would look like depending on Microsoft’s stock price:

As you can see the relation is very linear. As the price increases, your investment becomes more valuable.

Call Option

Have you ever heard of stock options? Buyers get the right to buy or sell at a given price within specific dates. The buyer of a call option receives the right (against money) to buy stock at a given price. He will do so if the price increases above the price of the strike. Want an example? If you buy a call 25 you will do the following:

-Exercise if the price is above 25$
-Not do anything if it is lower

Depending on the price you paid for the option, it can turn out to be a good move or not. For example, if you purchased an option for 1$, you would need the stock to go above 26$ to make a profit. Why? Simply because exercising means you would buy the stock for 25$. If it’s worth 27$, then you make a 2$ profit on the stock and you paid 1$ for the option. However, if the stock is worth 25.50$, you will exercise but still lose money.

Selling the option

One method for investors to make regular income is to sell these shares. If you sell them without owning the shares, that is called naked selling, which we will not cover here. However, if you own 100 shares of Microsoft and sell 1 call option (which covers 100 stocks), your risk is very limited. Even if the stock doubles, you would not “lose money”, you would simply not make as much profits on your shares.

Here is a table with a few scenarios:

Please note that the market value of a sold option can turn negative. If you sell a call, as you can see in the chart just above, when the stock price increases, your “liability” increases. Of course, since you also own the stock, those two balance each other out. That does mean that any increase above the strike price will have no overall impact on your investment (positive impact on your stock and negative on the call that you sold).

How Much Income Will This Add?

Honestly, this will vary a lot over time. Why? Mostly because it depends on the manager’s views but also on the market. When the market becomes very volatile, the “value” of call options increases making it more “worthwhile” to sell them. In periods where the market is flat and does not move much, you will end up making less money with this strategy.

The End Result

The end result is the following:

-You get additional income by selling the option
-Your possibilities in terms of capital gains if the stock increases are more limited

Suppose you did this strategy every single month? And that you did this not only on Microsoft for on 100 different stocks? A covered call ETF is just that. How would I describe it?

Let’s compare it to a regular index:

Hopefully that answers your questions but I’d love to hear more if you have additional ones.