5 Downsides To Covered Call ETFs

Trading costs

The Covered Call ETF tends to have fairly high trading costs since so many transactions are carried out each year. This is not unique to the Covered Call ETF or even to ETFs in general – it is a cost that you will have with any type of investment scheme based on frequent trades.

etfsManagement costs

Just as with any other investment form where you rely on active management carried out by salaried managers, there will be management costs associated with the Covered Call ETF. The Covered Call ETF is not a passive index fund – it is an actively managed fund and this shows when it comes to management costs.

The Covered Call ETF will under-perform in fast upward trending markets

The basic design of the Covered Call ETF means that it can be expected to under-perform significantly in markets that ascends quickly, e.g. a market that is going through a rapid bounce-back after a minor crash.

Example: The fund issues a call option for 100 shares in Apple. The call option is sold and the fund receives the premium. Now, the share price of Apple begins to soar. On the expiry date, the holder of the call option decides to exercise it since the strike price is much lower than the market price of 100 Apple shares. To honor their call option, the fund is obliged to sell 100 Apple shares to the option holder for the strike price.

By issuing a call option, the fund assumes a downside risk exposure while simultaneously limiting most of the upside potential. If the fund had refrained from issuing an option and just owned Apple shares instead, the fund would have profited from the market price increase.

Lack of transparency

If you invest into a truly passive index ETF, you will be able to know exactly what’s going on with the fund at pretty much any time. With the Covered Call ETF, you give up some of this ability to know what the managers of the fund are doing. You still know more than you would with a hedge fund, but less than with a passive index EFT.