The technology sector, particularly the technology companies within the Nasdaq 100, has long captivated investors with its blend of innovation, rapid growth, and significant market influence. Giants like Apple, Microsoft, and Nvidia drive the markets with advances in artificial intelligence, cloud computing, and digital transformation, making the sector a magnet for those seeking high returns. Yet, the same qualities that fuel tech’s meteoric rise also make it one of the most volatile corners of the market. Rapid shifts in consumer demand, regulatory scrutiny, and competition can send stock prices soaring or plummeting in a matter of days.

For investors, this volatility presents both opportunities and risks. While the sector’s dramatic swings can lead to substantial gains, they can also expose portfolios to steep losses. One effective strategy has gained traction to help mitigate this uncertainty: covered call writing. By selling call options on tech stocks they already own, investors can generate income from high option premiums, which are often driven upward by the sector’s volatility. At the same time, the strategy provides a degree of downside protection, cushioning against price fluctuations inherent to tech investing.

Covered calls thus offer a compelling way to play the volatility of Nasdaq 100 technology companies, balancing the pursuit of yield with a measure of risk mitigation.

What Are Covered Calls?

A covered call is an options trading strategy that enables investors to generate additional income and protect against the downside by writing call options. In this approach, the call writer sells options on securities they already own, generating income from the premiums received. The term “covered call” indicates that the investor holds the underlying security, allowing them to deliver shares if the option buyer decides to purchase the shares.

In essence, when an investor writes a covered call, they grant the buyer of the option the right, but not the obligation, to purchase their shares at a specified price, known as the strike price, within a predetermined timeframe. This strategy allows investors to generate income from the premiums collected on the sold call options, providing an additional revenue stream on top of any potential capital appreciation from the underlying stock.¹

In the case of a high-volatility tech stock, premiums received from selling options can help offset any potential losses if the stock price declines, acting as a form of downside protection. If the stock price rises above the strike price and the investor has to sell, they benefit from the premium received as well as any price appreciation up to the strike price.

Writing covered calls on high-volatility tech stocks comes with unique advantages. Given the inherent price fluctuations in this sector, options premiums are typically higher, allowing investors to capitalize on the increased demand for options. This dynamic not only enhances the income potential from the strategy but also provides a cushion against the inevitable ups and downs of tech stocks. As investors seek ways to navigate the volatility of the Nasdaq 100, covered calls stand out as a compelling strategy to generate income while managing risk.²

High Volatility in Tech

The technology sector of the Nasdaq 100, is known for its volatility, which can be attributed to the sector’s relentless pace of innovation. Firms in this sector operate on the cutting edge, introducing new products and services that reshape markets. Examples like artificial intelligence, cloud computing, and other innovative technologies show why the tech sector is an ideal backdrop for covered call strategies. Because while innovation fuels growth potential, it can also lead to abrupt shifts in investor sentiment, particularly when earnings reports, regulatory changes, or competitive advancements are announced.³

This volatility is a double-edged sword, however. While it introduces risk, it also creates lucrative opportunities for investors employing strategies like covered calls. High volatility typically translates into elevated options premiums, making it an ideal environment for selling options. As stock prices fluctuate, the premiums on call options increase, allowing investors to capitalize on the heightened demand for these contracts.⁴

However, an experienced active manager can balance the volatilities and premiums in order to give investors the best possible experience. An experienced manager assess their calls and adjust them depending on the volatilities at the given point in time. For example, they may write further out-of-the-money to generate the same premiums as before if volatilities are higher.

Downside Risk Mitigation in Covered Calls

In addition to the potential for elevated premiums, employing a covered call strategy also equips investors with a tool to mitigate risk and navigate potential market corrections or uncertain times.

In an environment where tech valuations can swing dramatically, the additional income from call premiums provides a buffer against price fluctuations. For instance, if a tech investor holds a stock that appreciates modestly or experiences price stability during a volatile period, the income from covered calls can offset potential losses and enhance yield. This dual benefit of the prudent use of covered calls not only amplifies returns but also fosters a more resilient investment approach, softening the impact of volatility and allowing tech investors to navigate turbulent markets with greater confidence.⁵

QQQY: Canada’s First NASDAQ-100® Technology-Focused ETFs

Looking for ways to boost your yield from the technology sector while mitigating risk? Looking for ways to take advantage of a pure tech play within the NASDAQ-100®?

QQQY is Evolve’s NASDAQ Technology Enhanced Yield Index Fund. QQQY offers investors an enhanced yield from exposure to a portfolio of 41 companies classified as “technology” on the Nasdaq 100 Index® by utilizing an active covered call strategy on up to 50% of the portfolio. Covered call options have the potential to provide extra income and help hedge long stock positions.

To learn more about the Evolve NASDAQ Technology Enhanced Yield Index Fund, please click here: https://evolveetfs.com/qqqy/.

Sources

1. Ganti, A., “Covered Calls: How They Work and How to Use Them in Investing,” Investopedia, April 11, 2024; https://www.investopedia.com/terms/c/coveredcall.asp
2. Laboe, D., “Take Advantage of Elevated Volatility with Covered Call Options,” Nasdaq, January 13, 2022; https://www.nasdaq.com/articles/take-advantage-of-elevated-volatility-with-covered-call-options
3. Semenova, A., Dey, E., Reinicke, C. & Kniazhevich, N., “Stocks Sell Off a Day After Furious Rally as Volatility Returns,” BNN Bloomberg, August 01, 2024; https://www.bnnbloomberg.ca/business/technology/2024/08/01/stocks-sell-off-a-day-after-furious-rally-as-volatility-returns/
4. “Understanding Implied Volatility and Historical Volatility in Options Trading,” Options Desk, n.d.; https://optionsdesk.com/resource-centre/intermediate-options/options-volatility/
5. Farley, A., “The Basics of Covered Calls: How to Lower Risk and Potentially Increase Profits with This Simple Options Strategy,” Investopedia, September 12, 2024; https://www.investopedia.com/articles/optioninvestor/08/covered-call.asp

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