- Covered call ETFs provide high income through option writing but limit upside in strong bull markets.
- When comparing Global X covered call ETFs (e.g., ENCC, GLCC, QQCC) to their non-covered call counterparts, the covered call versions generally underperform, especially in sectors with strong growth like NASDAQ 100.
- While some sectors (oil, gas, and gold) showed less disparity in performance, long-term investors in covered call ETFs should be mindful of their potential limitations during bull markets.
In this post, we are going to analyze covered call ETFs, particularly those managed by Global X. Covered call ETFs can provide exposure to certain sectors while generating a high income from writing call options. These can provide an excellent income stream when used properly. However, every strategy comes with shortfalls. One of the main drawbacks of covered call ETFs is the limitation on upside potential in bull markets, as the call options force writers to sell stocks. While the covered call strategy can perform well in flat or mildly bullish markets, it is not immune to risks from the underlying holdings. If the ETF’s underlying assets, such as the NASDAQ 100, fall sharply, the covered call ETF will also suffer losses.
The best way to evaluate covered call ETFs is by backtesting their stock prices and distributions and comparing them with similar non-covered call ETFs. Here, we compare several Global X covered call ETFs (formerly Horizon ETFs) with their non-covered call counterparts over a 5-year period.
We look at: ENCC (Global X Canadian Oil and Gas Equity Covered Call ETF), GLCC (Global X Gold Producer Equity Covered Call ETF), QQCC (Global X NASDAQ-100 Covered Call ETF), USCC (Global X S&P 500 Covered Call ETF), and CNCC (Global X S&P/TSX 60 Covered Call ETF). They are compared to XEG (iShares S&P/TSX Capped Energy Index ETF), XGD (iShares S&P/TSX Global Gold Index ETF), QQQ (Invesco QQQ Trust, Series 1), SPY (SPDR S&P 500 ETF Trust), ZEB (BMO EQUAL WEIGHT BANKS INDEX ETF), and XIU (iShares S&P/TSX 60 Index ETF).
First, comparing ENCC and XEG (oil and gas sector ETFs), ENCC slightly underperforms. However, when dividends are factored in, the performance is more or less on par. Some bull market periods show smoother price action for ENCC compared to XEG, but the discrepancies are minor enough for long-term investors to overlook.
Next, comparing GLCC and XGD (gold sector ETFs), GLCC slightly underperformed, but the degree of underperformance remained consistent over the 5-year period, especially after the COVID-19 crisis. Aside from this abnormal market event, GLCC's performance closely mirrored XGD.
Larger discrepancies appear when comparing QQCC (Global X NASDAQ-100 Covered Call ETF) to QQQ. QQCC significantly underperformed QQQ, especially during NASDAQ 100’s growth phases. Even with dividends reinvested, QQCC’s total gains are much lower than QQQ, likely disappointing long-term investors.
With USCC and SPY (S&P 500 funds), USCC gained ~75% over 5 years, compared to SPY’s 100%+ gain. This reflects an underperformance of about 25-30%.
The similar underperformance can be observed when we compare BKCC and ZEB. The theme here is that it didn't capture the gains from bull market of 2021-2022 as much as its counterpart ETF.
Finally, CNCC (S&P/TSX 60 Covered Call ETF) underperformed XIU, with the gap widening gradually from 2020 onward.
Overall, Global X covered call ETFs tend to underperform their non-covered call counterparts, particularly in sectors that experienced bull markets in the last 5 years, such as NASDAQ 100 and S&P 500. Investors looking for high dividends from sectors like NASDAQ 100 or S&P 500 may want to consider alternatives. However, for those seeking exposure to the oil, gas, or gold sectors, ETFs like ENCC or GLCC could offer attractive high-income options. Notably, these sectors did not benefit from the same bull market as tech, which might explain why their covered call versions performed relatively well. It remains to be seen how these ETFs will perform if a future bull market emerges in these sectors.