As investors scramble to deal with dividend cuts and depressed bond yields, alternative income ideas such as covered call writing stand out. For many investors, the Nationwide Risk-Managed Income ETF (NYSEArca: NUSI) is a more practical idea for accessing the benefits of these covered calls.
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 generating 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.
Covered call strategies such as NUSI can potentially augment a portfolio during periods of heightened volatility. The covered-call options allow an investor to hold a long position in an asset while simultaneously writing, or selling, call options on the same asset.
NUSI Makes It Easy
While covered calls can offer income-generating benefits, the strategy can be tricky, particularly when investors are going it alone on individual equity holdings.
“First, do not use this strategy with positions that you are unwilling to sell. Sooner or later the positions will be called away from you, albeit at a nice profit if you execute it correctly. However, if shares do start to rise and you begin to have second thoughts, below I add some pointers on what you can do,” writes Robert Napier for Investing Daily.
A covered call refers to an options strategy where an investor writes or sells a call option on an asset which they already own or bought on a share-for-share basis to generate income via premiums derived from the sale of the call options.
The Nationwide Risk-Managed Income ETF uses an options trading strategy called a protective net-credit collar seek to generate income. The options strategy sells an upside call option and uses a portion of the proceeds received to buy a put option to hedge downside risk on an underlying portfolio of securities.
Another “caveat is not to use this strategy if you don’t want to lock in a loss. For example, if you bought shares of a company for $100, and they are now trading at $70, don’t sell a call with an $85 strike price unless you are willing to potentially lock in that loss,” according to Napier.
For more on income strategies, visit our Retirement Income Channel.
This article was prepared as part of Nationwide’s paid sponsorship of ETF Trends.
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.
An options contract is an agreement between two parties to facilitate a potential transaction on the underlying security at a preset price, referred to as the strike price, prior to the expiration date.
Nasdaq-100 Index – A basket of the 100 largest, most actively traded U.S companies listed on the Nasdaq stock exchange.
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.
Protective Net Credit Collar – An options strategy that could provide short-term downside protection, offering a cost-effective way to protect against losses and allowing you to make some money when the market goes up.
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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.