My Passive Income Journal

Covered Call ETFs For Passive Income

Why Covered Call ETFs?

We all love passive income and covered call ETFs (exchange-traded funds) can be a powerful tool for generating income for investors. The covered call strategy involves holding a long position in an underlying asset, such as a single stock or an ETF, while simultaneously selling call options on that same asset. The sale of call options generate income for the investor.  

In the case of covered call ETFs, the ETF provider does all the selling of covered call options within the fund for you – all you do is sit back and watch the monthly distributions drop into your cash account. That’s passive income right there.

Covered call ETFs take this exact strategy and apply it to a diversified portfolio of stocks or other assets. By investing in a covered call ETF, investors can receive regular income payments via distributions while also gaining exposure to a diversified portfolio of assets.

In recent years it has not been unreasonable to expect between 9% – 13% income from covered call ETFs. Many covered call ETFs pay monthly distributions too.

One of the main benefits of covered call ETFs is that they can provide a much higher yield than traditional ETFs or mutual funds. Because the fund is selling call options on its underlying assets, it is generating much more additional income than can normally be distributed to investors via just plain dividends. This can be particularly attractive in a low interest rate environment where other income-generating investments may have limited potential.

How Covered Call ETFs Work

When an investor buys a share of a covered call ETF, they are buying a share of a fund that holds a diversified portfolio of underlying assets, such as stocks or other ETFs. The fund then sells call options on some or all of the underlying assets it holds.

A call option is a contract that gives the buyer the right, but not the obligation, to buy a specific asset at a specific price (known as the strike price) on or before a specific date. When an investor sells a call option, they are agreeing to sell the underlying asset at the strike price if the option is exercised.

In a covered call strategy, the fund sells call options on some or all of the underlying assets it holds. The options have a strike price that is higher than the current price of the underlying asset. If the price of the underlying asset remains below the strike price, the options will expire worthless, and the fund will keep the premium paid by the buyer of the option. This premium is then distributed to investors in the form of income.

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If the price of the underlying asset rises above the strike price, the buyer of the option may exercise their right to buy the asset at the strike price. The fund will then sell the asset at the strike price, which may limit the potential upside for the fund if the asset continues to rise in price. However, the premium received from selling the option can help offset any losses from the sale of the asset.

Important Things To Consider With Covered Call ETFs

In addition to generating income, covered call ETFs can also offer some downside protection too. Because the ETF is holding a long position in its underlying assets, it can benefit from some increase in price. However, by selling call options, the fund is also limiting its potential downside if the price of the underlying asset falls. If the price falls below the strike price of the call options, the ETF will not benefit from any further increase in price, but it will also not suffer the full loss. So, like all investments this strategy is not entirely risk-free.

When considering a covered call ETF, investors should evaluate several factors. One important consideration is the level of income generated by the ETF. Some covered call ETFs may have a higher yield than others, but this can also come with a higher level of risk. It is important to understand the underlying assets held by the fund, as well as the call options being sold, to assess the level of risk involved.

Another consideration is the expense ratio of the ETF. Like other ETFs or mutual funds, covered call ETFs charge an annual expense ratio to cover the costs of managing the fund. Investors should compare the expense ratio of different covered call ETFs to find the most cost-effective option.

It is also important to evaluate the performance of the ETF over time. Investors should look at the historical performance of the fund, including both its income generation and its total return. While past performance is not a guarantee of future results, it can provide valuable insight into the fund’s potential performance through various economic cycles.

Finally, investors should consider the overall asset allocation of their portfolio. Covered call ETFs can be a valuable addition to an income-generating portfolio, but they should not be the only investment. Never put all your eggs in the one basket! Investors should evaluate their overall investment goals and risk tolerance to determine the appropriate allocation to covered call ETFs.

In Conclusion – Covered Call ETFs For Passive Income

Overall, covered call ETFs can be a valuable tool for generating regular, high, passive income while also providing some market downside protection. For the record, we invest in some covered call ETFs in our cashflow portfolio.


Hugh Walker

By investing in a diversified portfolio of underlying assets and selling call options, these covered call ETFs can generate regular, passive income payments for investors – many pay monthly distributions which is a boon for those seeking a regular income stream.

However, investors should carefully evaluate the underlying assets, expense ratio, covered call methodology and historical performance of the ETF in order to make an informed investment decision.