Even the most off-base misconceptions can be hard to shake. It’s almost as if once something enters the consciousness, there it remains – no matter how inaccurate it may be.
It’s something that’s been happening among some investors with regard covered call option strategies within the ETF structure. The misconception, which goes back two decades, is that the aim of call options is to act purely as a shortfall rather than being a tool to generate income.
“It goes back to the early 2000s, when there were funds that would generate very high income and yet they would be writing covered call options on 100% of the portfolio,” says Paul MacDonald, CFA, Chief Investment Officer, Harvest Portfolios Group Inc. “So, in that particular scenario, that is true: you get all of the downside, less the premium, and none of the upside. But I think people are beginning to transcend that misconception now. Using the right covered call strategy, investors can participate in the upside – and get solid long-term growth – and also get a very high income.”
Harvest Portfolios uses a strategy to help investors achieve just that. All of the firm’s equity income ETFs write covered call options to a maximum of 33% on any position, which means at all times there’s a minimum of 67% of the upside capture. The strategy doesn’t only yield high income but also enables investors to participate in the long-term growth of the companies they invest in.
When it comes to implementing their covered call strategy, Harvest has a structured process that narrows down their portfolios to between 20 and 30 large-cap stocks. Depending on the mandate, they do it quarterly or semi-annually.
“On a month-over-month basis though, we’re looking at all of our underlying holdings and what call options are available on that and we then go through a process on how much that ought to be to write on each position, how much do we need to write in order to generate the net after withholding tax and after the income for that particular month,” says MacDonald.
“What we’re always trying to figure out is ‘Where can we get the best active premium?’ and ‘Why are we getting paid the active premium?’”
The hard work is paying off as all of Harvest’s covered call ETFs are showing good performance, with yields ranging from 5.25% to 9.34% (as of April 30).
However, both advisors and investors need to understand covered call options thoroughly to be able to take advantage of the benefits.
“I found even some sophisticated or relatively sophisticated investors do find some of the concepts around covered calls to be complex,” MacDonald says. “I think it’s about educating investors and advisors on some of the core ETF intricacies – on how they work but, in particular, how they go out and do it each month with those metrics.”
In order to help advisors get educated on covered call strategies and ETFs, Harvest has created a whitepaper titled “The Art of Covered Call Writing.” You can download it right here.
Harvest ETFs with Call Option Strategy (As of April 30, 2019 )
Harvest Healthcare Leaders Income ETF (HHL) 9.34%
Harvest Brand Leaders Plus Income ETF (HBF) 6.85%
Harvest Tech Achievers Growth & Income ETF (HTA) 6.48%
Harvest Energy Leaders Plus Income ETF (HPF) 7.88%
Harvest Global REIT Leaders Income ETF (HGR) 5.60%
Harvest US Bank Leaders Income ETF (HUBL) 6.10%
Harvest Global Resource Leaders ETF (HRES) 5.25%
Harvest Equal Weight Global Utilities Income ETF (HUTL) 6.60%
The above is for illustrative purposes only and refers to Class A Units only. Commissions, management fees and expenses all may be associated with investing in Harvest investment funds. The funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the relevant prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in unit value and reinvestment of all distributions and do not take into account income taxes payable by any security holder that would have reduced returns. Distributions are paid to you in cash unless you request, pursuant to your participation in a distribution reinvestment plan, that they be reinvested into Class A or Class U units of the Fund. If the Fund earns less than the amounts distributed, the difference is a return of capital. Tax, investment and all other decisions should be made with guidance from a qualified professional. Harvest Exchange Traded Funds are managed by Harvest Portfolios Group Inc.