Covered calls, or selling options, can be a meaningful addition to investors’ income strategies. For those that want that income without having to monitor the options market, the Nationwide Risk-Managed Income ETF (NYSEArca: NUSI) is worth considering.
NUSI is an actively managed portfolio of stocks included in the Nasdaq-100 Index and an options collar. Per index rules, the fund only invests in the top 100 largest by market cap, nonfinancial stocks listed on NASDAQ. A collar strategy involves selling or writing call options and buying put options, thus seeking to generate income to hedge some downside risk. The strategy seeks to generate high current income monthly from any dividends received from the underlying stock and the option premiums retained.
“A covered call can compensate to a small degree if the stock price drops, the short call expires OTM, and the short call’s profit offsets the long stock’s loss,” writes Scott Connor, director of trader education at TDAmeritrade.
Seeking To Reduce Risk
The Nationwide Risk-Managed Income ETF incorporates options exposure to help seek to generate income and mitigate risk as a way to enhance total returns. Investors have long used covered call options strategies for income generation or protective put options strategies to protect against and limit losses.
“You might be giving up the potential for hitting a home run if XYZ rockets above the strike price, so covered calls may not be appropriate if you think your stock is going to shoot the moon. But in markets that are moving more incrementally, this strategy could be beneficial,” notes Connor.
NUSI can act as a complement to traditional equity and fixed income allocations or as the ideal protective hedge for investors with heavy exposure to technology and growth stocks because the fund is a “rules-based options trading strategy that seeks to produce high income using the Nasdaq-100 Index,” according to Nationwide.
By selling calls and buying puts, NUSI presents investors with dual avenues for potential downside protection. Call writers typically want the underlying security to stay flat or decline somewhat because call options are long positions with unlimited upside potential.
“Covered calls, like all trades, are a study in risk versus return. With the tools available at your fingertips, you could consider covered call strategies to potentially generate income,” according to Connor.
To learn more about NUSI, read its fact sheet here.
For more on income strategies, visit our Retirement Income Channel.
Covered Call – A financial market transaction in which the seller of call options owns the corresponding amount of the underlying instrument, such as shares of a stock or other securities.
Nasdaq-100 Index – A basket of the 100 largest, most actively traded U.S companies listed on the Nasdaq stock exchange.
Collar – an options trading strategy that is constructed by holding shares of the underlying stock while simultaneously buying protective puts and selling call options against that holding.
A put is an options contract that gives the owner the right, but not the obligation, to sell a certain amount of the underlying asset, at a set price within a specific time.
Call options are financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity or other asset or instrument at a specified price within a specific time period.
Out The Money (OTM) – An expression used to describe an option contract that only contains extrinsic value. These options will have a delta of less than 50.0. An OTM call option will have a strike price that is higher than the market price of the underlying asset.
This article was prepared as part of Nationwide’s paid sponsorship of ETF Trends.
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KEY RISKS: The Fund is subject to the risks of investing in equity securities, including tracking stock (a class of common stock that “tracks” the performance of a unit or division within a larger company). A tracking stock’s value may decline even if the larger company’s stock increases in value. The Fund is subject to the risks of investing in foreign securities (currency fluctuations, political risks, differences in accounting and limited availability of information, all of which are magnified in emerging markets). The Fund may invest in more-aggressive investments such as derivatives (which create investment leverage and illiquidity and are highly volatile). The Fund employs a collared options strategy (using call and put options is speculative and can lead to losses because of adverse movements in the price or value of the reference asset). The success of the Fund’s investment strategy may depend on the effectiveness of the subadviser’s quantitative tools for screening securities and on data provided by third parties. The Fund expects to invest a portion of its assets to replicate the holdings of an index. Correlation between Fund performance and index performance may be affected by Fund expenses and because the Fund may not be invested fully in the securities of the index or may hold securities not included in the index. The Fund frequently may buy and sell portfolio securities and other assets to rebalance its exposure to various market sectors. Higher portfolio turnover may result in higher levels of transaction costs paid by the Fund and greater tax liabilities for shareholders. The Fund may concentrate on specific sectors or industries, subjecting it to greater volatility than that of other ETFs. The Fund may hold large positions in a small number of securities, and an increase or decrease in the value of such securities may have a disproportionate impact on the Fund’s value and total return. Although the Fund intends to invest in a variety of securities and instruments, the Fund will be considered nondiversified. Additional Fund risk includes: Collared options strategy risk, correlation risk, derivatives risk, foreign investment risk, and industry concentration risk.
Nasdaq-100 Index: An unmanaged, market capitalization-weighted index of equity securities issued by 100 of the largest non-financial companies, with certain rules capping the influence of the largest components. It is based on exchange, and it is not an index of U.S.-based companies. Market index performance is provided by a third-party source Nationwide Funds Group deems to be reliable (Morningstar). Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses have been reflected. Individuals cannot invest directly in an index.
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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.