With markets tanking and inflation offsetting dividend yields, covered call options are another way of generating income. However, the strategy may be too complex for some clients.
“Right now is the ideal time to be investing in covered calls,” said Nirujan Kanagasingam, vice-president and head of ETF strategy at CI Financial.
A fund that writes covered call options can generate “very strong yields, especially in a market environment where there’s higher volatility,” Kanagasingam said in an interview.
Equity markets have plunged this year after registering large gains since March 2020, while bond markets are having a historically bad year. Kanagasingam said it’s a good environment for covered call funds, which allow investors to generate income from covered call premiums while staying exposed to the market.
But covered call funds must sell the shares upon which the call was written — at the strike price — if the option buyer exercises their right, even if the share price continues to rise. As a result, the fundholder gives up upside potential.
Therefore, funds with covered call options tend to perform better in flat markets or bear markets, Kanagasingam said, not commenting on any particular product.
“Investors get to keep that premium from selling that call option in periods of high market volatility,” Kanagasingam said. “When you take a look at bear markets, an investor will likely outperform in this environment. As you sell call options, you are able to generate some of that income, which can help offset some of the stock decline.”
When you invest in funds that write covered call options, “you are betting against yourself, in a sense,” said Peter Worsley, a wealth advisor with Vancity/Credential Securities in Coquitlam, B.C.
He said that while “mechanically, they work great,” covered call products may be too complex for some clients — particularly those most worried about losing money, for whom the simplest option is best.
“With all due respect to the average retail customer, they don’t want it,” he said.
More sophisticated clients may want to consider covered calls with inflation chewing away at real returns.
“Even though interest rates have started to rise, it’s still hard to find income in this environment,” Kanagasingam said. “Real [interest] rates are still negative and even dividend yields are still below the rate of inflation.”