Equity investors should temper their expectations as earnings growth could slow this year. If we are in for a more sideways trending market, covered call exchange traded fund strategies could help generate attractive returns.
There are a few covered call, or “buywrite,” ETF options available. For instance, the Powershares S&P 500 BuyWrite Portfolio (NYSEArca: PBP), the largest buywrite ETF based off the S&P 500 with $381.8 million in assets, has a 12-month yield of 5.05%, and the Horizons S&P 500 Covered Call ETF (NYSEArca: HSPX), which also employs a covered call strategy on the S&P 500, has a 2.96% 12-month yield.
Additionally, the Recon Capital NASDAQ-100 Covered Call ETF (NasdaqGM: QYLD), which provides a covered-call strategy that targets Nasdaq-100 securities, has generated a robust 11.08% 12-month yield. [A Covered Call ETF Strategy Produces Big Yields]
The covered-call options strategy allows an investor to hold a long position in an asset while simultaneously writing, or selling, call options on the same asset. Traders would typically employ a covered-call strategy when they have a neutral view of the markets over the short-term and just bank on income generation from the option premium. [ETF Chart of the Day: Call Coverage]
In a flat market condition, the trader would use the buy-write strategy to generate a premium on the option. If shares fall, the option expires worthless and one still keeps the premiums on the options. However, the strategy can cap the upside of a potential rally – the trader keeps the premium generated but any gains beyond the strike price will not be realized.
For instance, during the rally in equities over the past year, the covered call ETFs’ performance lagged behind benchmark index ETFs. Over the past year, PBP rose 5.1% and HSPX gained 8.8% while the SPDR S&P 500 ETF (NYSEArca: SPY) increased 15.9%. Meanwhile, QYLD was up 2.7% over the past year whilePowerShares QQQ (NasdaqGM: QQQ) advanced 19.8%.
However, with growth moderating this year, the covered call strategies could be a good way to generate yields while leaving a foot in the equities market.
Headwinds like a stronger U.S. dollar and lower energy prices could weigh on earnings growth ahead, reports Jeremy Glaser for Morningstar.
The U.S. dollar has been appreciating against a basket of foreign currencies. Consequently, U.S. companies, notably large-caps with large international footprints, could see overseas revenue decline.
Additionally, after oil prices slipped about 50% off its high, the oil sector will see a significant cut to earnings as oil and gas producres experience a direct impact from low oil and gas prices.
“Forget about double-digit growth; we are looking at more like low- to mid-single-digit revenue growth,” according to Morninstar analyst Matt Coffina. “And I’d say a mid-single-digit rate, 4% to 6%, is much more realistic over the long run than sustained double-digit growth.
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Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.