This article was originally pubilshed at the Humble Dollar
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 (NASDAQ:QYLD) compared to that of the Invesco QQQ Trust (NASDAQ: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.