FREE NEWSLETTER

Goodbye Upside

Mike Zaccardi

SELLING COVERED calls can sound like a winning investment strategy, especially to yield-hungry investors frustrated by today’s low interest rates. Wouldn’t you know it? There are exchange-traded funds (ETFs) designed to mimic the strategy.

For background, covered calls are a yield-enhancement play that involve selling call options against stocks that you own. The call option gives you extra income, but—during the life of the option—your gains are capped at the call option’s strike price. Essentially, you give up the possibility of scoring big gains but receive extra income in return. If the stock goes nowhere—or even if it rises slightly—you get the call premium while still hanging on to the stock.

I was shocked when I saw the 2021 performance of Global X Nasdaq 100 Covered Call ETF (symbol: QYLD) compared to that of the Invesco QQQ Trust (QQQ), which tracks the Nasdaq 100. The Global X fund was up a paltry 10% last year, while the Invesco ETF soared 27%.

To be fair, selling covered calls is a fine endeavor so long as you fully understand the wager you’re making. During periods of sharply rising stock prices, selling away your upside potential is a losing strategy. But when a sideways or bear market strikes, collecting premiums by writing calls should outperform simply owning the shares outright.

Tempted to write covered calls? Keep in mind that trading options will likely be a wash over the long run, since options are a zero-sum game. It might even cost you because of the money lost to bid-ask spreads and to any commissions you pay. Perhaps more important, your best-performing stocks will likely be “called away”—and history tells us that a small number of huge winners account for much of the stock market’s gains.

Browse the Blog

Subscribe
Notify of
8 Comments
Inline Feedbacks
View all comments
John Yeigh
John Yeigh
8 months ago

I like covered calls, but I think of them more as a kind of bond surrogate and stock de-risker rather than as a complete stock substitute – the risk\return sits between pure stocks and low-yielding bonds. A significant allocation of covered calls has given me comfort to remain nearly fully invested in stocks.
If looking mainly for “yield enhancement” with stocks that go “sideways”, I would also recommend less volatile dividend stocks versus the more volatile and often higher growth Nasdaq stocks. Nasdaq calls do pay more, but the potential upside forfeited is also higher.
Still, I think there can be a place in the portfolio allocation for stocks, stocks with covered calls, and bonds.

Luckless Pedestrian
Luckless Pedestrian
8 months ago

Why would the author be “shocked” by the disparity in share price performance between QYLD and QQQ, given that QYLD yields 11.8% while QQQ yields just .46%? The former fund is designed to generate income whereas the latter is designed for growth. Seems like an apples vs. oranges comparison.

Mike Zaccardi
Mike Zaccardi
8 months ago

Yeah, I figured QYLD would have underperformed, but that return difference just seemed huge to me.

Jonathan Clements
Admin
Jonathan Clements
8 months ago

Giving up 17 percentage points of return seems pretty shocking to me — and highlights the downside of writing covered calls.

Ormode
Ormode
8 months ago

I tried buying stock for the sole purpose of selling covered calls on it, but that didn’t work out either. So I’ve given up on the whole thing.
If you want to try real options trading, then open a separate account and see how you do. If you lose all the money, quit.

Purple Rain
Purple Rain
8 months ago

I used to make a lot of money making covered calls and prided myself on how savvy I was. Until two years later. I noticed how mediocre my portfolio was. All the good companies got called away and I was also losing precious dividend income and growth in the process.

Now, I stick to selling puts. I do covered calls only if it is a company I don’t want to hold long-term in my portfolio.

Andrew Forsythe
Andrew Forsythe
8 months ago

Mike, thanks for this. Your comments, and Jonathan’s article you referenced at the beginning, are a clear and succint explanation of this tactic, along with its downsides.

Mike Zaccardi
Mike Zaccardi
8 months ago

Thanks Andrew. And here’s a fun nugget: I found that the Russell 2000 covered call ETF crushed the Nasdaq 100 covered call ETF. A flip of the underlying indexes! https://twitter.com/MikeZaccardi/status/1481349886427770882

Free Newsletter

SHARE