Covered Call ETFs vs SMAs
Covered call ETFs have existed for nearly two decades, but it wasn’t until recently that the offerings went mainstream. A covered call strategy involves selling upside calls1A call is the right of the owner to buy a specified security at a set price at or prior to maturity of the call. For more information: https://www.investopedia.com/terms/c/calloption.asp against a long security position (e.g., stock or ETF). The covered call strategy will generally outperform if the stock declines, is neutral, or, due to the premium collected when selling a call, even if the stock moves up mildly. If the stock moves up strongly, the strategy will underperform the position consisting solely of the stock but can potentially provide tax optimization. In general, the addition of a covered call overlay generates income, reduces portfolio volatility and creates the potential for superior risk-adjusted returns.
The pioneer in the ETF space was Invesco, launching the Invesco S&P 500 BuyWrite ETF (PBP) in 2007. Early covered call ETFs were scarce and generally implemented a very straightforward strategy with a market index – own the index and then seek to enhance returns via selling calls on it.
Over the past four years, dozens of new covered call ETFs have emerged, each with its own unique investment strategy and risk/return profile. Two of the more popular ones today are the JPMorgan Equity Premium Income ETF (JEPI) and the JPMorgan Nasdaq Equity Premium Income ETF (JEPQ). JEPI launched in May 2020 and has ballooned to over $33B in assets under management, while JEPQ began trading in May 2022 and has amassed over $13B in holdings in two years. These ETFs implement an active management strategy where the portfolio managers both choose the underlying securities and then sell upside calls against the stock holdings to generate yield.
JEPI and JEPQ Assets-Under-Management (AUM) Growth
Separately Managed Accounts (SMAs) have become popular vehicles for customized investment solutions. With ETFs or mutual funds, investors have ownership in the fund and the fund owns the underlying securities. These are generally universal, “one size fits all” investment pools. With SMAs, the investor directly owns the securities, and the investment strategy is personalized to fit each individual according to their risk tolerance, needs, and goals. One application of an SMA is to implement option overlay strategies on the client’s portfolio. Someone looking to generate additional income from their stock holdings can hire a third-party manager, like Exceed, to design and manage a covered call strategy to best fit their needs. This allows an investor the flexibility to choose their own underlying securities-or simply retain the securities that they already have-and determine an appropriate level of income and potential equity upside given their risk profile and liquidity needs.
In addition to customization and direct ownership, SMAs also offer more transparency and provide potential tax efficiencies as compared to an ETF. A holder of an active ETF is 100% at the mercy of the portfolio managers and any reallocation decisions, which can have short-term tax consequences. An SMA structure allows the investor to always know the exact level of exposure that they currently have, allowing a level of discretion in managing positions and potentially offering some tax optimization.
There are some drawbacks to using SMAs versus ETFs. SMAs typically require higher minimum investments than ETFs – most require a minimum investment of at least $50,000. Additionally, the SMA manager will charge a fee on the assets being managed and the broker will charge commission on the trades, but these fees are generally in line with those of other active covered call ETFs. Lastly, SMAs require more client attention than ETFs. The investment manager will do most of the legwork, but this will require some level of communication with the client to periodically review their financial goals and monitor progress.
A covered call SMA can be a valuable alternative for advisors and investors looking to generate income from existing models and stock positions. Additionally, it can assist in tax optimized sell programs for concentrated positions, among other use cases. Ultimately, the covered call SMA is an important tool for advisors to be aware of in helping clients meet their ultimate financial objectives.
Contact us for a consultation on how you can put your stock holdings to work and create your own custom income stream.
IMPORTANT DISCLOSURE: The information in this blog is intended to be educational and does not constitute investment advice. Exceed Advisory offers investment advice only after entering into an advisory agreement and only after obtaining detailed information about the client’s individual needs and objectives. No strategy can prevent all losses or guarantee positive returns. Options trading involves risk and does not guarantee any specific return or provide a guarantee against loss. Clients must be approved for options trading at the custodian holding their assets, and not all retirement accounts are permitted to trade options. Transaction costs and advisory fees apply to all solutions implemented through Exceed and will reduce returns.