Covered Call ETFs on the ASX

Global X has recently issued three covered call ETFs on the ASX:

  • S&P/ASX 200 Covered Call ETF (AYLD)
  • S&P 500 Covered Call ETF (UYLD)
  • Nasdaq 100 Covered Call ETF (QYLD)

The US has for a long time been spoilt with choice when it comes to ETFs and especially income-focused ETFs. To appreciate how much choice Americans have on covered call ETFs, you only need to look at the Global X US website to see they provide 12 different covered call ETFs to Americans:

What is a covered call ETF?

A covered call ETF uses a “covered call” strategy which involves the fund manager not only holding stocks and collecting dividends but also making additional income by selling call options against those stocks. The catch is that the call option gives the buyer the right to buy the stock from the fund manager if it goes up in value. This effectively means that the upside growth of a covered call ETF is curtailed because stock price increases allow the buyer of the call option to take the stock away from the fund manager. On the other hand, the covered call ETFs in theory provide downside protection because, if the stock prices goes down, the buyer of the call option cannot buy the stock and the fund manager pockets the income from selling the call option.

Betashares already provides covered call ETFs

Although Global X has recently issued AYLD, UYLD, and QYLD on the ASX, Australia’s own Betashares has already had covered call ETFs listed on the ASX. YMAX, which is a covered call ETF that invests in the top 20 Australian companies, has been around since 2012 whereas UMAX, which is an S&P500 covered call ETF, has been around since 2014. Betashares recently issued QMAX, which is a Nasdaq 100 covered call ETF, was recently issued in October 2022.

Something that definitely jumps out about covered call ETFs from Betashares is their high management fees. YMAX as a MER of 0.69%, UMAX’s MER is 0.79%, and QMAX’s MER is 0.68%. However, all of Global X’s ETFs have a MER of 0.60% making them slightly cheaper.

Betashares ETF, MERGlobal X ETF, MER
Australian equity covered call ETFYMAX, 0.69%AYLD, 0.60%
S&P 500 covered call ETFUMAX, 0.79%UYLD, 0.60%
Nasdaq 100 covered call ETFQMAX, 0.68%QYLD, 0.60%

Given that YMAX and UMAX has had such a long track record, we can look at their performance over time.

As the chart above shows, YMAX (in blue) has been on a steady decline since it was issued in 2012 whereas UMAX has been increasing. In fact, one seems to be a mirror image of the other, with UMAX rising about 30% since inception whereas YMAX has declined about 30% which means that if you invested half in YMAX and half in YMAX, you’d effectively be holding cash.

Of course, investors do not invest in covered call ETFs for price alone. They are focused on dividends. According to Market Index, YMAX has a dividend yield of 8.92% so far whereas UMAX has a dividend yield of 7.18% which means if you invest half in YMAX and half in UMAX, you’d effectively be invested in cash but in a high interest savings account that pays about 8% with franking credits.

It is curious why YMAX has underperformed UMAX so substantially, but I suspect the explanation comes from the volatility of investing in the top 20 ASX stocks. Because investing in only 20 stocks on the ASX means much of the money is concentrated in Australia’s miners and big bankers, this increases volatility compared to the broader, more diversified and more stable S&P500. As such, to compensate for the higher volatility, the buyer of the call option will pay less, which results in a lower options premium for the fund manager who is the issuer of the call option.

This volatility explanation for why YMAX underperforms UMAX can also be seen in covered call ETFs on the US markets. For example, QYLD, Global X’s Nasdaq 100 covered call ETF QYLD (of which there is a Reddit community called r/qyldgang), has underperformed XYLD, which is Global X’s S&P 500 covered call ETF.

In the chart above, QYLD (in blue) has underperformed XYLD (in orange) over a long period of time. Whereas the top companies in Australia are dominated by bankers and miners, in the US the top companies are dominated by tech firms such as Google, Apple, Microsoft, and Amazon. Given that the Nasdaq 100 index is concentrated mostly in tech and internet companies, there is more volatility, which may mean lower options premiums for the fund manager, which results in under-performance.

However, a quick Google search shows that the dividend yield of QYLD is about 11% compared to 7% for XYLD. This is also analogous to YMAX vs UMAX where YMAX underperformed YMAX on price but made up for it with higher dividend yield.

Buying multiple covered call ETFs to balance income and price

What this suggests is that blending different covered call ETFs can be used as a strategy during early retirement to draw down income but also preserving capital so that you do not run out of money. For example, if you retire at 50 with $2 million in net worth, you may wish to put it all in an Australian equity or Nasdaq 100 covered call ETF because you don’t have long to live but you have a lot of net worth, so you can afford some capital depletion. However, if you retire at 35 with $750k and want to live overseas in developing countries, you may wish to put it all into S&P500 covered call ETFs which hopefully will provide more capital preservation at the expense of lower dividend yield. If you retire at 45 with $1 million, it may be a blend of all S&P500, Nasdaq 100, or ASX covered call ETFs e.g. half in YMAX and half in UMAX. You can mix and blend to balance capital preservation and dividend yield.

Selling off high growth investments (such as crypto or property) during retirement and putting it into covered call ETFs is an alternative approach rather than selling off 3% or 4% at a time. When selling off assets, for many people there is psychological stress that they may run out of money. Putting everything in high dividend ETFs (including covered call ETFs) is a much simpler way to generate income for retirement.

Disclosure: Image made using Stable Diffusion. I hold YMAX and UMAX.