Was I Wrong About Covered Calls?

Quick Overview

Covered call funds underperform their underlying equity benchmarks over the long term, primarily because they cap upside returns while maintaining downside risk exposure, which is exacerbated by the high implied costs demonstrated through withdrawal analysis and comparison to enhanced covered call funds.

Key Points: Over a 10-year period ending August 2025, the Global X S&P 500 Covered Call ETF (QYCC.TO) trailed the iShares Core S&P 500 Index ETF (XUS.TO) by an annualized return of 3.15 percentage points (12.43% vs 15.58%). The BMO Covered Call Canadian Banks Fund Series ETF (ZWB.TO) underperformed its comparable BMO Equal Weight Banks ETF (ZEB.TO) by 2.96 percentage points annually over 10 years. Withdrawal analysis shows that covered call strategies limit upside participation when the underlying asset price rises above the strike price plus premium collected, meaning investors miss out on significant gains. The implied cost of these products is substantial, requiring an additional breakeven fee ranging from 1.45% to 2.68% annually just to match the ending wealth of the underlying equity portfolio over 10 years. Enhanced covered call funds, which use leverage, have outperformed both standard covered call funds and their underlying equity counterparts in recent short-term periods, suggesting that leverage in this strategy can boost returns without significantly increasing downside risk in those specific periods. The speaker argues that covered call funds do not generate true passive income, as the income derived from selling options is offset by capped upside returns and retained downside risk, making the strategy detrimental for long-term investors. The speaker, Ben Felix (CIO of PWL Capital), discloses that his firm manages portfolios that do not use covered call ETFs, indicating a potential conflict of interest regarding his critical stance.

Context: The video addresses the common claim that covered call funds provide reliable, passive income while maintaining performance comparable to simply holding the underlying stocks. The speaker, Ben Felix, Chief Investment Officer at PWL Capital, analyzes historical performance data, withdrawal simulations, and compares standard covered call funds against enhanced (leveraged) versions and their underlying equity benchmarks to test the validity of these claims, particularly for long-term investors.