The Horizons S&P 500 Covered Call ETF (HSPX) began trading today, joining a small number of existing exchange-traded products that are based on a covered call strategy.

The fund is a collaboration between Horizons Exchange Traded Funds Inc., a Toronto-based exchange-traded fund provider, and Exchange Traded Concepts LLC (ETC), a company in Edmond, Okla. whose turnkey platform helps bring ETFs to market more quickly and less costly than doing it from scratch.

HSPX is a passive fund that tracks the S&P 500 Stock Covered Call Index. The fund invests in the securities of the S&P 500 Index in substantially similar weights to the index, and sells, or writes out-of-the-money call options on up to 100 percent of each of the option eligible securities in the index.

Covered call writing is an options strategy where an investor holds a long position in an asset and sells call options on that same asset as a way to generate additional income from the option premium. With out-of-the-money call options, the exercise, or strike price of the option is above the market price of the security.

Covered call strategies typically work best in bear and rangebound markets where they can generate income and dampen volatility. But the strategy isn’t ideal in raging bull markets because the buyer of the premium has the right to purchase the security at a specified price, which can cap the upside potential of the security.

The Horizons S&P 500 Covered Call ETF is one of three covered call strategy funds in registration with the Securities and Exchange Commission that were filed by Horizons, which has a suite of 12 covered call-focused ETFs in Canada with nearly $500 million in assets. The other two funds in registration are the Horizons S&P Financial Select Sector Covered Call ETF and the Horizons S&P Energy Select Sector Covered Call ETF.

“We came out with the S&P 500 covered call fund first because it covers large-cap, U.S. stocks and is a broad measure that’s in most investors’ portfolios,” says Howard Atkinson, managing director of Horizons USA, which is the HSPX fund’s subadvisor. “This is a new equity answer to investors’ desire for more income.”

The options sold by the fund are rolled monthly on option expiration day, and the process is based on an automated, standardized methodology. Atkinson says stocks in the S&P 500 must meet certain qualifications to be eligible for options writing, and that on any given month they expect to be able to write options on between 300 to 400 stocks.

As for the fund’s expected yield, neither the fund nor its underlying index have a track record (the index was formally launched on June 12). The overall yield on the S&P 500 was a shade more than 2 percent as of Friday’s market close.

“Before we launched the fund we looked at annualized yield, and including dividend income, it was in the 7 percent range,” Atkinson says. “But that’s very dependent upon volatility, and at that time the volatility on the S&P 500’s individual stocks wasn’t as great as it became in the past few weeks. Among other things, the yield will really depend on the underlying volatility of the underlying stocks in the S&P 500 index. It’s hard to project [the yield] going forward.”

The fund’s expense ratio is 0.65 percent.

Other Covered Call ETFs

Two other covered call-related exchange-traded products––one an ETF; the other an exchange-traded note––are based on the CBOE S&P 500 BuyWrite Index. The index measures the returns of a buy-write, or covered call strategy based on buying an S&P 500 stock index portfolio and writing one-month call options listed on the Chicago Board Options Exchange.

The PowerShares S&P 500 BuyWrite Portfolio (PBP) fund has had an annualized return of 0.77 percent since inception in December 2007, and was up 1.87 percent year-to-date through Friday. The fund has significantly trailed the S&P 500 index during those respective timeframes.

This PowerShares ETF has attracted assets of $190 million, and has an expense ratio of 0.75 percent. The fund’s SEC 30-day yield was 2.42 percent as of Friday.

The iPath CBOE S&P 500 BuyWrite Index ETN (BWV) has generated annualized returns of 1.38 percent since its May 2007 inception and had gained 4.81 percent year-to-date through Friday. The ETN has $9 million in assets, and its expense ratio is 0.75 percent. The note doesn’t generate excess yield per se; rather, the yield that’s produced is part of ETN’s total return. 

Garrett Stevens, CEO of ETC, says the big difference between the underlying index of these two funds and the index underlying the Horizons S&P 500 Covered Call ETF is that the former writes options on the total return of the S&P 500 index while the latter writes options on individual stocks within the index.

“We have 400-something options in the portfolio at a given time that roll over each month,” he says. “That creates much better yield than writing options on just the index.”