Covered call ETFs are a popular investment option for investors looking to generate passive income from the stock market.
These ETFs offer a unique strategy that allows investors to earn a high yield (usually somewhere between 8% and 12% yield) while reducing investment volatility risk.
In this article, we will discuss how investors can use covered call ETFs to generate high yield income and we provide 4 scenario examples of how investors can benefit from this investment strategy.
Scenario Examples of Living off Covered Call ETFs
Example 1: Partially Living off Covered Call ETFs in Retirement
Meet John. John is a retiree looking for ways to generate passive income to cover his living expenses. He has a portfolio of $1,000,000 and is interested in investing in a covered call ETF that generates a yield of 10% per year.
After doing his research, John decides to invest $200,000 of his money in a covered call ETF that generates a yield of 10% per year.
This portion of John’s investment portfolio will provide John with an annual income of $20,000, which he can use to help cover his living expenses.
John can also reinvest the remaining $800,000 of his portfolio in other types of investments to diversify his holdings and potentially generate additional income or capital gains. By using a covered call ETF to generate passive income, John can enjoy his retirement without having to worry about managing a complex investment portfolio actively.
Example 2: Using Covered Call ETFs to Supplement Income
Suppose Jane is a working professional looking for ways to supplement her income.
She has a portfolio of $50,000 and is interested in investing some of it in a covered call ETF.
After doing her research, Jane decides to invest $10,000 in a covered call ETF that generates a yield of 9% per year.
This investment will provide Jane with an extra annual income of $900, which she can use to supplement her salary and potentially pay off debt or save for a specific goal. This is the amount Jane needs each year to pay for flights to UK to see her parents.
Jane can also use the remaining $40,000 of her portfolio to invest in other types of assets, such as stocks or bonds, to diversify her holdings and potentially generate additional income or capital gains.
By using a covered call ETF to supplement her income, Jane can reduce her reliance on her salary and potentially achieve her financial goals more quickly.
Example 3: Using Covered Call ETFs to Provide Full Income
Phillip is John’s next-door neighbour and they chat about investments regularly.
Unlike John, suppose Phillip started investing later in life and only managed to put away $400,000 towards retirement.
Phillip knows that if he invests this across normal stocks and bonds that the distributions will not cover his expenses.
Phillip needs his investment to cover all his expenses once he retires.
After doing his research, Phillip decides to invest his entire $400,000 across 3 different covered call ETFs which will produce an average yield of 1% per month (12% annually).
This investment will provide Phillip with an annual income of $48,000 a year or $4000 a month, which is enough to cover all Phillip’s budgeted expenses.
Example 4: Using Covered Call ETFs to Cover A Mother’s Lost Income
Mark and Julie have both worked as professional real-estate agents for a decade and have knuckled down and saved all of Marks income for 10 years and lived off Julie’s. This has given Mark and Julie savings of $650,000.
Mark and Julie have now started a family and Julie has recently given birth to their first baby last month.
They are now living off Marks wage and Julie no longer has a wage.
After doing their research, Mark and Julie invest the $650,000 under Julie’s name in several diversified covered call ETFs which will produce an average yield of 1% per month (12% annually).
This investment will provide Julie with an annual income of $78,000 a year or $6500 a month, which more than covers Julie’s previous wage and allows Mark and Julie to raise their children with one of them at home whilst covering all the added expenses in raising children.
Tips for Investing in Covered Call ETFs
Investing in covered call ETFs can be an effective way to generate passive income and reduce investment risk. Here are some tips for investors looking to invest in covered call ETFs:
- Do Your Research: Before investing in a covered call ETF, do your research to understand how the ETF works, what stocks it holds, and what its yield is. Make sure the ETF aligns with your investment goals and risk tolerance.
- Consider Fees: Like any other investment, covered call ETFs charge fees. Make sure to consider the fees when evaluating the potential returns of the ETF.
- Diversify Your Portfolio: While covered call ETFs can be a great way to generate passive income, they should not be the only investment in your portfolio. Make sure to diversify your holdings across different asset classes, such as stocks, bonds, and real estate, to reduce investment risk and potentially generate additional income or capital gains.
- Monitor the Market: The price of the underlying stocks can have a significant impact on the performance of covered call ETFs. Make sure to monitor the market and adjust your investment strategy accordingly.
What Are Covered Call ETFs?
Covered call ETFs are exchange-traded funds that hold a portfolio of stocks and sell call options on those stocks.
Call options give the buyer the right to purchase the underlying stock at a specific price, known as the strike price, within a set time frame.
By selling call options, covered call ETFs generate income for their investors, which can be distributed as dividends.
The term “covered” refers to the fact that the ETF holds the underlying stocks and can deliver them to the buyer of the call option if exercised. This strategy can provide investors with exposure to a diversified portfolio of stocks while generating income from the sale of call options.
We have written another article on covered call ETFs here – it’s a quick read with some other detail on the subject.
How Do Covered Call ETFs Work?
Covered call ETFs work by holding a portfolio of stocks and selling call options on those stocks.
The income generated from selling call options is distributed to investors as dividends, providing a consistent stream of passive income.
For example, suppose an investor holds shares of a covered call ETF that holds a portfolio of stocks worth $100,000 and sells call options on those stocks with a strike price of $110,000. If the price of the stocks does not rise above $110,000, the call options expire worthless, and the ETF keeps the income generated from selling the call options. However, if the price of the stocks rises above $110,000, the ETF will deliver the underlying stocks to the buyer of the call option, and the investor will earn a profit on the sale of the stocks.
The key advantage of covered call ETFs is that they provide a consistent stream of high yield income while potentially reducing investment volatility risk.
By selling call options, the ETF can generate income from the stocks in its portfolio, which can be distributed to investors as dividends.
This income can help offset any potential losses from the underlying stocks and provide investors with a steady stream of passive income.
In Summary – High Yield Income with Covered Call ETFs
Covered call ETFs can be an effective way to generate high yield passive income and reduce investment volatility risk.
By holding a portfolio of stocks and selling call options on those stocks, covered call ETFs can generate high yield income for investors, which can be distributed as dividends.
The ETF does the work, you just collect the distribution (often paid monthly)
Four scenario examples were provided of investors using covered call ETFs to generate passive income include retirees looking to cover living expenses and working professionals looking to supplement their income.
Investors looking to invest in covered call ETFs should do their research, consider fees, diversify their portfolio, and monitor the market.
By following these tips, investors can use covered call ETFs to achieve their cashflow and income goals.