Weekend Reading – Covered Calls Edition

Weekend Reading – Covered Calls Edition

Hey Folks!

Welcome to a new Weekend Reading post: the covered calls edition.

You can find some recent posts below before I get into my headline subject!

Wow, are these really the costs to raise children???

Weekend Reading – The costs to raise children

And…I recently posted my approach to keeping cash on hand, prior to semi-retirement and why I believe some form of a cash wedge is important to consider during retirement. Your mileage can always vary of course depending on your dependable income sources!

The Cash Wedge – Managing market volatility

Weekend Reading – Covered Calls Edition

My goodness, there are just so many ways to invest!

As passionate readers of this site know by now, I/we employ a two-pronged, hybrid approach to investing:

1. We own a number of Canadian dividend paying stocks for income and growth, you can read more about that on the dedicated My Dividends page here.
2. And, beyond a few U.S. stocks, we continue to invest and own low-cost ETFs for extra diversification. I also have a dedicated My ETFs page for that.

By investing the way we do, we feel we get the best of both worlds:

• meaningful income, now, today, if we wanted to use it via dividends and distributions, and
• our collection of stocks and ETFs also delivers price appreciation over time, ETFs moreso, providing growth. 

Win-win.

But certainly some investors invest very differently to meet their goals. I’ve mentioned that many times before on this site and I also mentioned as much during this recent TD webinar – stay tuned, recording to follow!

(In this recent webinar, I joined Adrian Starinieri from Passive Income Investing, and Henry Mah from Your Ever Growing Income to discuss the potential benefits of dividend investing as a way to build wealth compared to other investing strategies. I shared what works for me/us as a hybrid investor and how it likely differs from both Adrian and Henry.)

Using covered call strategies or at least covered call ETFs to juice income has been a very alluring income investing approach for many DIY investors. That’s good, to a point but to each their own since lots of financial engineering is involved. 

Here is the covered call strategy in a nutshell:

• Call options are financial contracts.
• The contracts give the buyer the right, but not the obligation, to purchase a security at a set price.
• This set price is called the strike price.

A covered call gives someone else the right to purchase stock shares you already own (hence “covered”) at a specified price (strike price) and at any time on or before a specified date (expiration date).

So, covered calls can potentially earn income on stocks you already own.

Of course, there’s no free lunch: your individual stocks could be called away at any time during the life of the option.

Source: Investopedia.

You don’t have to perform covered calls with individual stocks of course. You can own funds/ETFs to do the heavy lifting for you. Those also come with caution IMO since any active money management comes with higher fees passed onto the customer. 

Pros and Cons of Covered Calls / Covered Call ETFs

I’ve written about what I think about covered calls on my site before.

I don’t practice this approach nor do I ever intend to. 

While there is the income upside to be had and that has major appeal to many, there are just too many drawbacks and variables for me since income/yield and price appreciation is always two-sides of the same investing coin.

Sure, some covered call ETFs offer great income but the total returns could be flat.

Case in point below. I know some covered call income investors have touted this covered call ETF below. Why not just buy and own the index instead?

Source: Portfolio Visualizer (disclosure: I own QQQ (blue line) and not QYLD).

As this Globe and Mail article so kindly expressed (subscription):

“Covered call ETFs create an alluring image of high income and low risk, but these perceived attributes are a sleight of hand in financial product design. The final blow, in my view, is their high fees and costs and unfavourable tax implications.”

Mark

My name is Mark Seed - the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I'm looking to start semi-retirement soon, sooner than most. Find out how, what I did, and what you can learn to tailor your own financial independence path. Join the newsletter read by thousands each day, always FREE.