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To Covered Call Or Not Covered Call

Byadmin

I was recently reminded that BMO has these cool covered call ETFs on various sectors:

  • ZWB – BMO Covered Call Canadian Banks ETF
  • ZWU – BMO Covered Call Utilities ETF
  • ZWC – BMO Canadian High Dividend Covered Call ETF
  • ZWK – BMO Covered Call US Banks ETF
  • ZWT – BMO Covered Call Technology ETF

Previously, a few of ETFs were backtested against each other, and it turns out that the non-covered call version performed better than the covered call version in a bull market.

Over a three-year period – 2019 through 2021, ZEB returned 54% while ZWB returned 26%. Not including dividends.

The biggest criticism of covered call funds has always been that they miss out on the upside in a bull market. In a massive bull market, as we had in 2020 and 2021, they really miss. They get a very little premium from the covered calls and the stocks get called away every month.

But we’re not in a bull market anymore. 2022 has been a bear market. This should be the covered call time to shine. Let’s see!

It’s a lot closer. The covered call bank ETF fell -11.5%, while the non-covered call version fell -10.5%.

A 1% difference over a 6-month time period might not even be statistically relevant, except these two funds hold the same stocks. The difference is the covered calls. I’d expect the extra income of the calls to beat the lack of income of the straight stocks.

I wonder how to explain that. You would think that the income from the covered calls would expire worthless, and be a net addition to the performance of the underlying stocks.

How can a covered call strategy lose more money than owning the straight stocks in a down market?

One explanation is that we are not accounting for the additional monthly dividends the CC ETF pays. It’s 4.1% vs 6.9% – over 2.5% difference. That alone would put the performance of the funds around even.

Also, the MER of the CC fund is over 0.50% higher, so that counts against that income. You’re paying more to get worse performance.

But still, the performance of the covered call ETF does not seem to justify its usage even in a bear market. So far at least.

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