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.”