Exchange traded funds continue to increase in number and popularity, growing to one of the most commonly traded securities on the stock exchange as both institutional and the average retail investor gain greater access to broad or specialized market exposure. Yet many individuals are unfamiliar with ETFs’ inner workings. In this ongoing series, we hope to address your questions and help shed light on the investment vehicle. [What is an ETF? — Part 25: Commodity ETFs & Taxes]
In the ongoing search for yield, some investors have discovered buy-write ETFs and their attractive payouts over 10% in some cases. Still, like most investments, it is better to have a handle on the inner workings of the fund before actually diving in.
The buy-write, or covered call, strategy utilizes call options on a position to generate high income from option premiums. An investor would sell a call option above the current price of a security. If the price of the security is below the option upon the expiry date, the investor would pocket the difference.
Buy-write traders would only lose out on the difference of the exercise price and the market price. During market turns, traders can lose money if the security drops by more than the amount of the premium received – the premium acts like a buffer in case of significant market dips.