When it comes to equity income, there’s a perception that dividend-paying companies are light on growth. The recent space of debuted and growing payouts among tech giants such as Apple (NASDAQ: AAPL) and Microsoft (NASDAQ: MSFT), among others, has altered that scenario for the better.
Still, it’s fair to say that many companies in the high dividend camp aren’t exactly growth stocks. Additionally, covered call strategies, including exchange traded funds, have become useful assets in the income-generating toolbox. However, those products typically don’t deliver significant upside potential.
Fortunately, the covered call ETF segment is evolving. Issuers now offer products that keep with the income tradition of this asset while offering some upside potential. The Global X Nasdaq 100 Covered Call & Growth ETF (QYLG) and the Global X S&P 500 Covered Call & Growth ETF (XYLG) are examples of covered call ETFs that offer more upside participation than the old guard funds in this category.
Inside Covered Call ETFs “Plumbing”
As their names imply, QYLG writes covered calls based on the Nasdaq-100 Index (NDX) while XYLG does the same with the S&P 500. However, there’s more to the story.
“For example, Global X’s flagship covered call & growth strategies, QYLG and XYLG, write ‘at-the-money’ (ATM) covered calls on 50% of their respective portfolio’s assets while leaving the remaining 50% of the portfolio uncovered,” according to Global X research. “Therefore, these strategies have the potential to achieve half of the upside of well-known equity indices, the Nasdaq 100 (for QYLG) and the S&P 500 (for XYLG) with attractive yield potential while maintaining a level of exposure to sectors that are typically not found within high dividend screening strategies.”
In plain English, QYLG and XYLG can generate more capital appreciation than a standard covered call ETF. They can do this while not subjecting investors to a significant reduction in income. Proving as much, QYLG has a trailing 12-month dividend yield of 5.44%, while the comparable metric on XYLG is 5.30%.
In addition to the ETFs’ tempting income traits, the funds are relevant at a time when stocks are grinding higher and there headwinds in the bond market, including Fitch Ratings’ recent downgrade of the U.S. sovereign credit rating.
“If broader U.S. equity markets continue to trend upward, strategies like these would be expected to maintain 50% of their reference index upside plus any collected premiums from their call writing strategy,” concluded Global X. “QYLG and XYLG have also demonstrated lower levels of downside volatility, a measurement of tail risk, than their reference indices and may be able to provide a level of risk management should equity markets reverse course from what we’ve seen over the last 6 months.”
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