Following last weeks discussion on the step by step of how to write covered calls, I coincidentally ran across a thread in Canadian Money Forum about a couple of new covered call ETFs – HEX and ZWB.  These offerings are from Horizons AlphaPro ETF and BMO ETF families.

How do these work?  The ETF holds a group of stocks for you, writes “out of the money” covered calls on the stocks, and distributes the premiums and dividends to the shareholder.  The result is a distribution that is significantly higher than a typical dividend ETF.  For example, ZWB currently distributes slightly over 9% and HEX over 15.5%.  However, be aware that they have a limited distribution history so it’s likely that the yield will bounce around a bit.

BMO Covered Call Canadian Banks ETF (ZWB)

As the name of the ETF suggests, ZWB tracks the big Canadian banks and writes out of the money covered calls against them.  This ETF is great for those who want exposure to the Canadian banks but want a supercharged yield.  The MER of this ETF is a bit higher than regular index ETFs at a rate of 0.65% but makes up for it in its yield.  It’s difficult to gauge how this ETF performs relative to the bank index as it’s so new, but it’s current yield is a juicy 9.41%.

Here is a breakdown of the ETF by name and percentage holdings.

  • BMO Equal Weight Banks ETF 50.32%
  • National Bank of Canada 9.03%
  • Toronto Dominion Bank 8.82%
  • Royal Bank of Canada 8.72%
  • CIBC 8.47%
  • Bank of Nova Scotia 8.11%
  • Bank of Montreal 7.76%

Horizons AlphaPro Enhanced Income Equity ETF (HEX)

While ZWB tracks Canadian banks, HEX more or less tracks the Canadian index and writes covered call options against the holdings.  HEX holds all the largest market cap stocks on the TSX in equal proportions so it offers more diversification than ZWB.  The MER is the same as ZWB (0.65%) but with a higher yield which is currently close to 15.5%.  Again, HEX is extremely new with only 2 monthly distributions thus far.

Here is a breakdown of the ETF by name and percentage holdings.

  • Barrick Gold Corp 3.4%
  • BCE Inc 3.4%
  • Bank Of Montreal 3.4%
  • Bank Of Nova Scotia 3.3%
  • Cameco Corp 3.0%
  • Canadian Imperial Bk of Comm 3.2%
  • Canadian Natural Resources Ltd 3.3%
  • Canadian National Railway Co 3.3%
  • Cenovus Energy Inc 3.3%
  • Encana Corporation 3.3%
  • Enbridge Inc 3.4%
  • Goldcorp Inc 3.4%
  • Great West Lifeco Inc 3.5%
  • Husky Energy Inc 3.3%
  • Imperial Oil Ltd 3.4%
  • Ivanhoe Mines Ltd 3.2%
  • Manulife Financial Corp 3.3%
  • Magna Intl Inc 3.0%
  • Potash Corp Of Saskatchewan 3.3%
  • Power Financial Corp 3.4%
  • Rogers Communications Inc 3.4%
  • Research In Motion Ltd 2.9%
  • Royal Bank Of Canada 3.4%
  • Sun Life Financial Inc 3.4%
  • Silver Wheaton Corp 3.1%
  • Suncor Energy Inc 3.4%
  • Teck Resouces Ltd 3.4%
  • Toronto-Dominion Bank 3.4%
  • Thomson Reuters Corp 3.3%
  • Transcanada Corp 3.4%

Things to Consider

As covered calls can limit the upside of a stock, the largest drawback of these ETFs would be during bull markets.  With quickly appreciating prices, writing out of the money calls would likely be called away, thus forcing the ETF to re-purchase the stock at higher prices to keep the equal weighting of the ETF.  On the other hand, I can see these ETFs performing very well in sideways or even bear markets as the premiums collected will cushion any downward movement.

For me, I would like to see a bit more history and volume before adding a position.  What are your thoughts on these new ETFs?  Would you buy them for your portfolio?

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  1. Echo on May 23, 2011 at 5:10 pm

    These sound like better choices for me, some things are best left to professionals.

    The problem with all of these new ETF’s is just like you said, there is no history. I’d like to see actual results from a bull and bear market. A lot of hedge funds failed to perform as advertised during the last market crash.

  2. cannon_fodder on May 23, 2011 at 10:15 pm

    I’d be interested in reviewing them again in at least six months from now. Hopefully the market will have seen some ups and downs and status quo so we can get a glimpse as to how these ETFs will react.

    Is there a similar US ETF structure with long history we can purchase while we wait for these two?

  3. Ed Rempel on May 23, 2011 at 11:19 pm

    Hi FT,

    I would think the opposite – they would underperform more in bear and sideways markets. In bull markets, there is more optimism, so the calls would tend to be farther out of the money. The premiums would likely be lower, but the chance of being called away would also be lower.

    What you lose with selling calls is unexpected large gains. They would tend to happen more often in bear markets when there is too much pessimism, or when there is unexpected news, such as big announcements, takeovers or unexpected economic news.

    The reason that investors that use covered calls tend to make less over time it that these unexpected large gains actually happen much more often than people think. Taking large gains out of your return usually costs more than the premiums bring in.


  4. Dan on May 24, 2011 at 1:32 am

    my 2 cents….i sort of disagree with both FT and Ed. Covered call’s usually have the largest premium in a volatile market. Regardless of if it’s a “bear” or “bull” or sideways market, as long as prices are volatile, people are willing to buy calls at larger premiums. I imagine that we the sort of market place we are in currently, these sorts of etf’s should do well for the time being, and could be good ideas for a small portion of the income section of ones porfolio.

  5. The Dividend Ninja on May 24, 2011 at 1:36 am

    Excellent Article!

    I too have been intrigued with these ETFs, especially with the exceptional yields. Couch Potato also covered ZWB recently as well. However I am hesitant to purchase (1) They are essentially actively managed, that makes me think of mutual funds (2) As everyone points out, there isn’t a lot of history to them, and (3) as Ed points out, we really don’t know how these ETFs will respond in a bear-market cycle. There is just too many “ifs” for me to start jumping in just for the yield.


  6. Matt on May 24, 2011 at 10:54 am

    I already own ZWB and am considering adding a HEX position to my portfolio. Love the idea!

    cannon_fodder: check out the following link for a list of US covered call ETF’s.

  7. TFo on May 24, 2011 at 8:55 pm

    Would this be a good investment for a Smith Maneuver account? I guess these distributions would be taxed as regular income as opposed to the pure dividend play.

  8. Joe S. on May 24, 2011 at 9:41 pm

    Extremely skeptical. One should apply fundamental investing principles for a quick analysis and conclusion.

    Increased return cannot be expected without increased risk. There are two possibilities.

    1. If the return is indeed sustained at 10% (significantly higher than what can be expected of the market), the risk of losing most of your money is very real.

    2. Alternatively, if it is not as risky as it seems, the overall return will be similar or less to that of the general market over time, and investors will lose out with the higher fees.

    I would not recommend more than 5% of a portfolio in such a fund until more data is available (ideally 10+ years). Especially with yields so high, so early. That should have any investor’s ears ringing with the sounds of warning bells.

  9. FrugalTrader on May 24, 2011 at 10:00 pm

    @TFo, I wouldn’t use it for an SM investment account because we dont’ know exactly what the distributions are. It is possible that the distribution has a portion of ROC which is not typically recommended for a leveraged account.

  10. Nate on May 26, 2011 at 12:25 am

    From the Horizon Beta Pro website…. “Distribution Tax Treatment: Call option premium as capital gains and dividends as dividend income” .

    The distribution does not have a ROC component. I own HEX in my leveraged account…this is an excellent product.

    I’m surprised there is confusion to the other question on performance. FT was right…it will underperform in a bull market (call options will be exercised) and obviously outperform in a bear or flat market (collect the premiums).

  11. Millionaire on May 29, 2011 at 9:57 pm

    I recently analyzed the US covered call etfs LCM, DPD, PBP and a few others. The oldest ones have been introduced in 2005-06 so you can see how they went through 2008 and 2009. They tend to be a less volatile than their regular etf conterparts and when you factor in the dividend yields (8%+) the returns are a lot higher than their regular etf conterparts. The new canadian ones have yields of 10 and 15% which I agree is probably not sustainable but even if they cut the dividends in half it’s a lot better than most efts and stocks out there.
    You want my opinion? I jumping right in.

  12. The Financial Blogger @ on June 13, 2011 at 7:04 pm

    I currently hold position in ZWB (bought it a few weeks ago)

    My friend is a trader and offer a full site on covered call etfs. I’ve inluded the link in my name in order to not be spammy ;-0

    Nice post FT!

  13. OIIIIIIIO on June 29, 2011 at 1:05 am

    it’s about time, finally an ETF covered call in Canada…bought 300 shares @ $15…now I don’t have to do it myself…now I don’t have to worry about rolling over and paying commission when my stock gets called away

  14. iv on September 12, 2011 at 9:43 pm

    Something strange happen today to my position of HEX at Questrade. I do not see the HEX symbol anymore but just numbers … and of course it looks like I have 100% loss :-(

    At the same time the EFT continues to be traded according to google finance …

    any idea?

  15. STU on November 9, 2011 at 2:20 am

    I think these are great. They give me access to option trading which is too complex for me. The trader at Horizons seems to have a good reputation and history. If I have to pay more in taxes so be it. Otherwise it would be like passing on that higher paying job because you would have to pay too much in extra taxes. The only downside for me is the dividend is variable. I keep averaging the past payouts to get an idea of what the next one might be.

  16. Mike on July 27, 2012 at 5:58 pm

    I’m not big on the gold producers so instead of hex i am leaning towards Zwu

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