SHOULD YOU BUY THESE RED-HOT FUNDS?

Covered-call ETFs are popular but come with plenty of caveats.

- ANDREW TANZER

EVEN by the high-growth standards of the world of actively managed exchangetraded funds, the boom in a new breed of option-linked, income generating funds known as covered-call funds has been dazzling. Since 2022, nearly 80 have been launched, according to investment research firm Morningstar, and $65 billion of net inflows have poured into them.

The attraction of these ETFs, often dubbed “boomer candy,” is understandable. Through some financial engineering, they can provide relatively high and steady levels of monthly income (annual yields in the low-doubledigit percentages are common) even when linked to an index such as Nasdaq, whose stock components pay negligible dividends. Moreover, covered-call funds have the effect of tamping down volatility of the stocks or indexes they track.

At the same time, many financial advisers are skeptical whether investors adequately grasp the trade-offs entailed in what they’re buying. “There are things that investors probably don’t totally understand when they buy and hold covered calls,” says Jonathan Treussard, founder of Treussard Capital Management. “For example, are you okay with giving up market upside but retaining downside risk in exchange for income?”

Before we look at some of the pros and cons of this burgeoning corner of the ETF universe, let’s briefly examine how they work. (There are a multitude of different strategies of varying complexity, but we’ll use a simple example to illustrate the dynamics.) An investor can sell (or write) a call option, a form of derivative, on an individual stock or on a market index such as the S&P 500.