Canadian and American stocks have taken a beating through this year’s market volatility amidst a backdrop of surging inflation, rising interest rates, and concerns about a recession. One of the best ways to gauge volatility is with the Chicago Board Options Exchange (CBOE) Volatility Index (VIX), often referred to as the “fear index.”
The VIX measures the price volatility of one-month put and call options for the S&P 500. When the index is down, it suggests investors are bullish and not worried about the risk in the stock market. Conversely, when the VIX is up it means investors are nervous about market volatility.
The index spiked in 2008 during the U.S. financial crisis and again in early 2020 as a result of uncertainty around COVID-19. The VIX has been on the rise since the start of 2022, which suggests investors are increasingly nervous.
While some investors choose to sit on the sidelines during periods of volatility, there is a way to generate income in a choppy market—through covered calls. A covered call is an options strategy used to generate income from investors who believe stocks are unlikely to rise much over the near-term.
What Is a Covered Call?
A covered call is a two-pronged strategy where an investor has a long position in a stock and then sells call options on the same equity which is equivalent to the underlying long position. Through a covered call, investors sell someone the option to buy a stock they own at a set price for a set period of time. When selling the option, the buyer has to pay the seller a premium, which they get to keep as income from selling the option. The seller is essentially earning a premium from the buyer for missing out on potential gains.
The option that is sold is “covered” because the investor owns enough shares to cover the transaction if it’s exercised.
What Are the Benefits of Covered Call Strategies?
The biggest benefit of a covered call strategy is that it can generate premium income, enhance investment returns, and help investors target a selling price that is higher than the current market value.
If the stock moves up to the strike price, the seller generates profit from the long position. If the call expires, the seller collects the entire premium from the sale. Even if the shares have fallen in price the seller made money from the premiums or can be seen as having lost less money than if the options sale didn’t happen.
Selling covered calls is a popular strategy for long-term investors who want to generate additional income from their portfolios. When volatility is higher options trade at higher premiums because there is more uncertainty in the price of the underlying at expiration. This makes it more profitable to sell calls during such markets. At the same time, options trading can be complicated, and unless you understand the risks and benefits of selling options and managing positions, it should be left to an expert.
One way that investors can take advantage of options and covered calls is through a Covered Call ETF.
What Is a Covered Call ETF?
Through a Covered Call ETF, investors can hedge the stock market and generate income, even during one of the most volatile periods on Bay Street. A major benefit of a Covered Call ETF is that you don’t need to pick individual stocks or spend time keeping track of all the call positions. Because they’re actively managed, it’s the fund manager that is responsible for writing and managing the portfolio.
The current climate of high inflation and rising interest rates from the Bank of Canada has created economic headwinds for both equity and fixed income assets. Investors looking to generate income during the current macroeconomic environment should consider using a Covered Call ETF.
Investing in Covered Call ETFs
In Canada, there are a lot of ‘options’ to choose from when considering covered call ETF investments. In this rising-rate environment, covered calls are becoming increasingly popular, especially with yield-hungry investors.
If you’re thinking of investing in covered calls, consider these ETFs that utilize active covered call strategies in Canadian financials, materials and mining, U.S. banks, European banks and healthcare companies:
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