Unlock Income Potential: Covered Call Strategy FAQ

1. How Does Covered Call ETFs Work?

Covered call ETFs invest in stocks and sell call options on some of those stocks. Call options give buyers the right to buy the stock at a set price by a specific date. In exchange for selling the call options, the ETF receives a payment called a premium. If the stock price doesn’t reach the set price before the expiration date, the call option expires without value, and the ETF keeps the premium as income. But if the stock price reaches or exceeds the set price, the ETF has to raise cash to settle the option at that price, while still keeping the premium. This strategy reduces portfolio volatility, provides income, and protects against market downturns.

2. What are the advantages of adopting a covered call investment strategy?

The covered call investment strategy offers several advantages:

• Income generation^*: By writing call options on securities they already own, investors can earn premiums, which provide additional income.
• Downside protection: The premium received from writing call options acts as a cushion against potential losses in the value of the underlying securities during market downturns.
• Alternative strategy: Instead of keeping assets in cash or safe havens during market downturns, the covered call strategy allows investors to participate in certain degree of potential capital gains and dividend income.^#

* While Covered call writing limits potential gains of the underlying security, it provides a relatively stable option premium income for investors.

# Positive distribution does not mean positive return. Payments of distributions out of capital or effectively out of capital amounts to a return or withdrawal of part of an investor’s original investment or from any capital gains attributable to that original investment. Any such distributions may result in an immediate reduction in the Net Asset Value per Share of the Fund and will reduce the capital available for future investment.

3. What are the disadvantages of adopting a covered call investment strategy?

While the covered call strategy has its benefits, it also has some drawbacks:

• Limited upside potential: Profits from an increase in the value of the underlying securities are capped at the strike price of the call options, plus the premium received.
• Obligation to the purchaser: By writing call options, the investor gives the purchaser the right to receive a cash payment if the underlying securities’ value exceeds the strike price at expiration. This may result in missed opportunities for further gains.
• Underperformance during rapid rallies: When the value of the underlying securities rises rapidly above the strike prices of the call options, the strategy is expected to underperform the market.

4. How will the strike price of the written call options impact the covered call strategy?

The strike price of the written call options affects the covered call strategy in the following ways:

• Premium received: A higher strike price means that there is a lower probability that the option will be exercised, so the amount of premium received by the investor for selling the option is reduced.
• Downside cushioning: At-the-money options provide more downside protection because the strike price is close to or equal to the current price of the stock, and if the stock price falls, the investor can partially offset the loss by retaining the premium. Whereas, an out-of-the-money option (where the strike price is higher than the current price of the stock) may offer better upside return potential, but correspondingly less downside protection.
• Trade-off between premium and upside potential: Choosing a strike price involves a trade-off between the amount of the premium (which provides a downside cushion) and the limits on potential upside returns. A lower strike price may provide higher premium income, but it may also limit potential upside returns. Conversely, a higher strike price may reduce premium income, but also provides greater potential for upside returns.