Best Covered Call ETFs: Supercharge your Income

Dividend Earner

Dividend Earner

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5 min read Affiliate Disclosure

Covered call ETFs provide investors with an advanced income strategy without all the work and hassle of trading options on your own.

If you do it right, the strategy, applied to your favourite bank stocks, can increase your income by a couple of percentage points. But why not just go with the ZWB ETF or BMO Covered Call Canadian Banks ETF?

What Are Covered Calls?

A covered call is simply a clarification of a call option where the seller of the call option holds the underlying shares. If the buyer of the contract were to exercise it, the seller has the shares and can simply sell them.

When an investor sells call options for a premium, the investor pockets the premium if the options are not exercised when the contract expires.

The latter is how investors generate some extra income. The trick is in choosing the right price and time window. It’s an advanced investing skill.

The Best Covered Call ETFs

There aren’t many covered call ETFs, and only a couple of providers currently offer them. However, if they gain in popularity, that’s bound to change. Covered call ETFs may become popular Canadian ETFs as the population grows.

With ETFs, I like to look at a few criteria to make a selection. Since the strategy is for income, the yield is important in this case but it has to be a balance with the rate of return, or ROR for short.

In the case of ETFs, we need to look at the forward yield based on one of the recent payments, as distributions are inconsistent. You, therefore, need to take the yield as a range as it could be up or down from distribution to distribution.

The idea with a covered call ETF is to get the highest income while not taking any risks on the underlying assets. That implies that we do care about the underlying assets.

For example, the Canadian banks could be the safest, while a gold focus could be the riskiest.

While the TXF (CI Technology Covered Call ETF) has done really well and has paid a good yield, there is always a risk with technology. The NXF (CI Energy Giants Covered Call ETF) has done poorly in terms of value and is therefore discounted.

I would normally care about the NAV of the ETF but since this approach is for boosting a portfolio, a small NAV is fine.

I find FHI (CI Health Care Giant Cover Call ETF) to be the best opportunity, followed by ZWH (BMO US High Dividend Covered Call ETF). Both ETFs are focused on US stocks. To have a Canadian-covered call ETF in the list, the best one is ZWB (BMO Covered Call Canadian Banks ETF) for consistency and safety.

ZWB – BMO Covered Call Canadian Banks ETF

This is your safe play if you are very risk averse, but your income drops by 30% …

It’s pretty simple: The ETF holds the major banks and writes covered calls, which is what many DIY investors would do on their own.

ZWH – BMO US High Dividend Covered Call ETF

This ETF is doubling down on income by focusing on high-yield stocks and using covered calls to increase the income.

The ETF holds approximately 40 stocks from the US but they are not high yield as what you would expect from the ETF name. They are well-known mega-cap dividend stocks with a mix of strong dividend growers along with consistent dividend growers.

FHI – CI Health Care Giant Cover Call ETF

The ETF holds the top healthcare stocks from the US, which usually have less volatility than other sectors, and many pay a decent yield to add to the income from the options premium.

The ETF holds the top 20 healthcare stocks that you will all recognize and are an integral part of the North American healthcare system. They are primarily mega-cap stocks from a market capitalization.

Why Invest in Covered Call ETFs

You invest in covered call ETFs because you want to increase your income past the point of just using a financial ETF.

The best ETFs outlined may already be holdings in your stock portfolio. In this case, your risk and downside are already understood and limited.

How To Buy Covered Call ETFs

To buy a covered call ETF, you need a discount broker as ETFs trade like stocks on a stock exchange for ETFs. You specify the number of shares you want to buy from the selected ETF and whether you want to pay the market price or you enter the price you want to pay.

As it happens, many trading platforms offer access to free ETFs and you should use a discount broker with free ETFs if you can. Questrade is one of those discount brokers with free ETFs.

FAQ on Covered Call ETFs

Is a covered call ETF a good investment?

The short answer is no. It’s not a good investment for total returns and to grow a portfolio.

It’s good for increasing income in retirement.

How are covered call ETF taxes in Canada

It follows the same tax rules as ETFs and other equities.

You have to pay capital gains on the appreciation and you get a T3 for all the distribution reported by the ETF. It’s very similar to a REIT if you have experience with REITs.