Covered call Exchange-Traded Products (ETPs) typically hold a stock (or underlying asset) while selling call options on the same asset. Here, the ETP could collect income from option premiums but have limited upside potential if the stock price rises sharply. The success of this strategy depends on market conditions. Let’s explore how covered call options ETPs might perform in bull, bear, and sideways markets.
Bull markets
Prices trend higher in bull markets – this can be a mixed bag for covered call ETPs.
Capped growth potential: When the stock (or underlying asset) price moves above the option’s strike price, the ETP must sell the stock at that strike price. This can cap growth beyond the strike price.
More income potential: Bull markets can mean more demand for call options as investors take on more bullish bets. This demand can make call options more expensive (higher premiums) for call option buyers. But for call option sellers (in covered call ETPs), that can mean more income potential.
Note: Some IncomeShares EU ETPs sell out-of-the-money (OTM) call options to collect premiums. In bull markets, demand for OTM calls can be especially high because investors expect prices to rise above the strike price. So, they’re willing to pay a premium for the chance to earn more profit.
Steady income: If prices tick up gradually but stay below the strike price, the ETP collects regular premiums (income). It also doesn’t need to sell the stock too often to sacrifice growth potential.
Bottom line: In bull markets, covered call ETPs could sacrifice some growth for steady income potential.
Bear Markets
Prices trend lower in bear markets – but covered call options ETPs can still offer some advantages.
Outperformance potential: The premiums collected from selling call options can slightly offset the stock’s decline. This means the ETP might outperform holding the stock alone in a bear market.
Limited income potential: Falling prices often reduce demand for call options, which can lower the premiums earned.
Downside risk: While the premiums can help, they may not be enough to fully cover the loss in the stock’s value.
Bottom line: In bear markets, covered call ETPs might soften the blow of falling prices through premium income.
Sideways/choppy markets
Prices move sideways or stay range-bound in choppy markets. This can potentially be a good environment for covered call ETPs.
Steady income potential: The ETP collects premiums from selling call options, which can provide consistent income even when prices aren’t moving much.
Outperformance potential: In flat markets, the investor keeps the premium from selling call options. This might lead to outperformance compared to just holding the stock.
No major upside: In sideways markets, the stock price typically doesn’t rise too much. So, capped growth from selling call options isn’t a big drawback.
Bottom line: In sideways markets, covered call ETP can potentially turn stagnant price action into income opportunities.
Key takeaways
- Covered call options ETPs can generate steady income by collecting option premiums, but they limit upside potential in rising markets.
- In bear markets, premiums might soften losses, offering potential outperformance compared to holding stocks alone.
- Sideways markets can be favorable for covered call ETPs. Stagnant price action could potentially turn into consistent income opportunities
