It finally happened. The Dow index broke 20,000 points for the first time in history. It’s never been so high before. If the stock market was a rapper, it would be Snoop Dog. 😀 With valuations being stretched so much it’s important to be very selective about what investments we buy now. One wrong move and we could accidentally buy a stock that is nearing its peak.
Lowering Investment Risk With Covered Calls
So after looking at my options, 😉 I contributed some money into my TFSA earlier this month and purchased 200 units of BMO’s Covered Call Utilities ETF (ZWU.) This is enough to make it DRIP.
A covered call is an options strategy which generates income for investors, even in a bear market. We basically sell a call option on a stock that we already own. In doing so, we receive some money called a premium. 🙂
Related post: How to write a covered call (buy/write options)
Option strategies have slightly different risk considerations than owning a stock directly. For covered calls, we always get to keep the premium. But if the stock goes above the strike price, we have capped the gains we can make. Call options can reduce our risk because if the stock falls, then at least we’re getting paid to wait until it climbs back up.
This is why covered call strategies work best on low volatility stocks that are not expected to move up or down a lot. Essentially we want the stock to remain steady, or grow slowly. But most of the profit should be made from the juicy premiums. 🙂 I do not believe utility and telecom stocks can continue to grow at double digit rates, given how expensive their valuations are.
About BMO Covered Call Utilities ETF
I’ve sold covered calls before on individual companies. But I realized that it takes a lot of time to manage an options strategy effectively. So that’s why I have decided to buy a covered call ETF. Now I can sit back, relax, and let BMO take care of doing all the work for me. 😉
BMO Covered Call Utilties (ZWU) has an annual yield of 6.71%. 😀 The total MER is 0.72%, which isn’t bad considering it’s an actively managed fund. The fund invests in securities of utilities, telecoms and pipeline companies, while it dynamically writes covered call options that are out of the money. All options are rolled forward upon expiry.
Buying ZWU is one of the best ways to invest in a diversified portfolio of stable stocks while receiving a high yield at the same time. The 6.71% yield is not very risky even though it seems pretty high. Unlike a dividend yield, option premiums do not directly rely on the profitability of the underlying company.
Like any strategy, covered calls have advantages and disadvantages. And of course I’m still long many utility, pipeline, and telecom stocks in my margin account. But when used with specific types of stocks under the right investment plan, I believe covered calls can be a great way to lower the average cost, and reduce portfolio volatility. 🙂
Note: Premiums earned from selling options are considered capital gains for tax purposes. I hold this ETF in a tax advantaged account because it doesn’t pay eligible dividends.
Random Useless Fact:
The media can have large impact on how people perceive the world.