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"Investors can’t get enough of covered-call funds, which offer a way to stay invested in stocks without enduring all of the market’s gut-wrenching ups and downs. Recent events show that the funds largely deliver on that promise—though it comes at a heavy price in terms of missed returns."
Do all markets recover in one month? If they do, then theses funds are for suckers. Those who lost 50% in 2000-02 and 2007-08 may want these funds as a diversifier.
Say you owned GSPKX and SPY on Oct 9, 2007. That's one of just a few covered call funds that existed and used covered calls back then.
Between then and March 9, 2009, you would have lost 55.17% with SPY. GSPKX would have provided you around 3% of protection with its covered call income. You still would have lost 52.22%.
Yogi has pointed out that the downside protection provided by covered calls is limited. That limitation is no more apparent than when losses are large. The two funds track all the way down. That's not diversification; the call writing just gives a little daylight between the lines. (Data from M* chart.)
In case one wonders (as I did) whether GSPKX was really a covered call fund during the GFC, here are excerpts from its prospectus, then and now:
The Fund invests primarily in a diversified portfolio of common stocks of large-cap U.S. issuers represented in the S&P 500 Index and maintains industry weightings similar to those of the Index. The Fund seeks to generate additional cash flow by the sale of call options on the S&P 500 Index or related ETFs. The volatility of the Fund’s portfolio is expected to be reduced by the Fund’s sale of call options. .
The Fund invests, under normal circumstances, at least 80% of its net assets plus any borrowings for investment purposes (measured at the time of purchase) (“Net Assets”) in dividend-paying equity investments in large-cap U.S. issuers. ... The Fund seeks to generate additional cash flow and may reduce volatility by the sale of call options on the S&P 500® Index or other national or regional stock market indices (or related exchange-traded funds (“ETFs”)). The Fund expects that, under normal circumstances, it will sell call options in an amount that is between 20% and 75% of the value of the Fund’s portfolio. As the seller of the call options, the Fund will receive cash (the “premium”) from the purchaser
Not quite identical (the lawyers have had two decades to tweak the wording) but close enough.
Covered call funds differ in term of their objectives, design and execution. I’ve owned QQQX for about 5 years now, and am quite happy with its total return over that period and it’s relatively steady 7.5% distribution. It serves its purpose quite well.
By using options, one can create ("structure") financial instruments having virtually any behavior, at a cost of course. IMHO it's not much different from betting - not meant in a derogatory way. And unlike betting, when investing the deck is stacked in your favor. Over time, stocks go up and bonds pay principal and interest.
In horse racing, there are payoff odds on each horse. This is apparently more complicated than gamblers on team sports like. So there "products" are "structured" to offer even money bets. Instead of betting on which team wins with odds set accordingly, a derivative product is offered: one bets on team ± a spread.
In a similar, though more complex way, options can be used to package investment instruments. Want something guaranteed not to lose money? Package a zero coupon bond with a call option (on say, the S&P 500) so that you get some of the gain if the market goes up, and no loss if the call expires worthless.
If you're willing to give up some downside protection for a higher cap on potential gain, you can do that by using put options instead of zeros. See Schwab's description of buffered ETFs.
Income is certainly one reason why people use options such as covered calls.
Managed distribution funds (usually closed end) are something different. These are funds that, as PRESSmUP described, distribute a fairly steady stream of distributions by design. So long as those distributions are less than the total return of the fund (regardless of all is well and good.
From a black box perspective, it doesn't matter what the source of that total return is - dividends, gains (realized or unrealized), proceeds from selling options, proceeds from lending, etc. However, if the fund is distributing more than it is making, then it is eating into your capital, generally not a good thing.
QQQX runs hot and cold. 20%+ total returns in 2021, 2023, 2024. It was one of its category worst (100th percentile) performers in 2022 and YTD (per M*). Over the past five years, its NAV (and its market price) has gone up, so it hasn't been distributing more than it's made.
Comments
Between then and March 9, 2009, you would have lost 55.17% with SPY. GSPKX would have provided you around 3% of protection with its covered call income. You still would have lost 52.22%.
Yogi has pointed out that the downside protection provided by covered calls is limited. That limitation is no more apparent than when losses are large. The two funds track all the way down. That's not diversification; the call writing just gives a little daylight between the lines. (Data from M* chart.)
In case one wonders (as I did) whether GSPKX was really a covered call fund during the GFC, here are excerpts from its prospectus, then and now:
From its prospectus, April 29, 2008: From its current summary prospectus: Not quite identical (the lawyers have had two decades to tweak the wording
I should have listed the Ishares funds that use simple SP500 put options or DIVO that was mentioned in another thread.
MAXJ -July 1 2024 till June 30,2025 - guaranteed rate 0-10.6% for one year period.
MAXJ thus far has about 7% return compared to 11% for SP500.
https://www.ishares.com/us/strategies/investing-for-outcomes#navigate-risk
In horse racing, there are payoff odds on each horse. This is apparently more complicated than gamblers on team sports like. So there "products" are "structured" to offer even money bets. Instead of betting on which team wins with odds set accordingly, a derivative product is offered: one bets on team ± a spread.
In a similar, though more complex way, options can be used to package investment instruments. Want something guaranteed not to lose money? Package a zero coupon bond with a call option (on say, the S&P 500) so that you get some of the gain if the market goes up, and no loss if the call expires worthless.
If you're willing to give up some downside protection for a higher cap on potential gain, you can do that by using put options instead of zeros. See Schwab's description of buffered ETFs.
Income is certainly one reason why people use options such as covered calls.
Managed distribution funds (usually closed end) are something different. These are funds that, as PRESSmUP described, distribute a fairly steady stream of distributions by design. So long as those distributions are less than the total return of the fund (regardless of all is well and good.
From a black box perspective, it doesn't matter what the source of that total return is - dividends, gains (realized or unrealized), proceeds from selling options, proceeds from lending, etc. However, if the fund is distributing more than it is making, then it is eating into your capital, generally not a good thing.
QQQX runs hot and cold. 20%+ total returns in 2021, 2023, 2024. It was one of its category worst (100th percentile) performers in 2022 and YTD (per M*). Over the past five years, its NAV (and its market price) has gone up, so it hasn't been distributing more than it's made.