# BMO Covered Call Utilities ETF



## newfoundlander61 (Feb 6, 2011)

*BMO Covered Call Utilities ETF - ZWU*

What is the breakdown of distributions for this fund IE: interest etc.


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## Eclectic12 (Oct 20, 2010)

Google "BMO ETFs ZWU" ... look for the "ETF Products" link.

https://www.bmo.com/gam/ca/advisor/products/etfs#

Scroll down until you find "ZWU" then click on the link. 
Click on the "Tax & Distributions" button on the bar is about 1/3 of the way down that starts with "Overview" and ends with "Holdings".

The link will default to 2018 that won't have distributions yet. Use the drop box to switch to year "2017", which will then populate the last table on the page, the distributions breakdown.
https://www.bmo.com/gam/ca/advisor/...ns#fundUrl=/fundProfile/ZWU#tax&distributions


Cheers


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## humble_pie (Jun 7, 2009)

this page ^^ shows that during 2018, ZWU has distributed an amount of either $.07 or $.068 per share at the end of every month, for an annualized yield presently running at 6.65%

plus, the since-inception chart shows unit price rising more or less steadily, meaning long-term holders have paper gains.

on the face of things, what's not to like ... well, there are a number of problems that can beset covered call strategies, particularly during rapidly rising or sharply falling markets. These problems are technical to describe, i've posted before but plan to skip the technicalities here.

a stable, slightly-up-or-down market is best for covered call writing. Right now, one has to question the probability of such stability offering itself over the next little while.

(note to newfoundlander) with this ETF you won't be receiving the full dividend tax credit that you could receive from direct share ownership of canadian utilities, not to speak of the fact that the MER is on the high side. A portion of this BMO utilities ETF is invested in US companies; income as dividends & option gains will be flowed through to shareowners as 100% taxable foreign income. 

it's true that US utilities add diversification; but one could look for US exposure or foreign exposure by buying big canadian utilities such as Emera or Fortis, which are already active stateside.

i've mentioned this many times before: don't rush to buy US before considering quality canadian companies that own US or foreign subsidiaries meanwhile these beauts are paying 100% eligible canadian dividends with desirable dividend tax credits.



.


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## newfoundlander61 (Feb 6, 2011)

Thanks very much for this great post, my current holdings are just 2 banks the TD (40% approx of business in the US) & RY. Still looking at moving into over time to diversify but not in a hurry. There may be some lower price on stocks I am watching once tax loss selling has stopped but that is no guarantee either.


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## humble_pie (Jun 7, 2009)

newfoundlander61 said:


> my current holdings are just 2 banks the TD (40% approx of business in the US) & RY. Still looking at moving into over time to diversify but not in a hurry. There may be some lower price on stocks I am watching once tax loss selling has stopped but that is no guarantee either.



think you slow n cautious approach is well suited to the nervous times. Not just tax loss selling, it's the big trade wars, the constant real wars, the high tension wire atmosphere, the ubiquitous violence


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## newfoundlander61 (Feb 6, 2011)

Very true but my style is more the turtle approach than the rabbit approach


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## Eclectic12 (Oct 20, 2010)

humble_pie said:


> Eclectic12 said:
> 
> 
> > ... The link will default to 2018 that won't have distributions yet. Use the drop box to switch to year "2017" ...
> ...


It does show the 2018 distributions in what looks like YTD as it defaults to the current year. The original question however was about the breakdown, which won't be known until early 2019.

Sorry for not being clear but switching to the 2017 entry will give the previous year breakdown of the income types, as an idea of what may happen in 2018. It may shift somewhat but could be in line with the 2017 numbers.




humble_pie said:


> ... (note to newfoundlander) with this ETF you won't be receiving the full dividend tax credit that you could receive from direct share ownership of canadian utilities, not to speak of the fact that the MER is on the high side. A portion of this BMO utilities ETF is invested in US companies; income as dividends & option gains will be flowed through to shareowners as 100% taxable foreign income ...


The 2017 distribution breakdown confirms this with pretty close to equal parts of the distribution being "eligible dividends" and "return of capital" with about 10% "Foreign Income" plus a small amount of "Foreign Tax Paid". The 2016 breakdown is similar.



Cheers


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## james4beach (Nov 15, 2012)

A new person on the board mentioned this, so I was looking at it today. ZWU is performing much worse than regular utilities (ZUT) in total return. It also distributes a huge amount at 6.6% yield, using covered calls to effectively turn capital into cash.

There are probably many retirees who have come to rely on those distributions. There's $850 million invested in ZWU.

Look at the performance drag caused by BMO's covered call strategy. There are both inefficiencies in doing the options trades, plus stocks get called away. Based on performance since start of 2012, I see that ZUT has returned 6.6% CAGR and ZWU returned 4.6% CAGR. So ZWU has a performance drag (various reasons) of about 2% per year versus the actual stocks.

Let's forecast utilities sector performance of 6% CAGR long term. ZWU gets a 2% drag versus the sector, resulting in 4% CAGR total return.

Now ZWU spits out a 6.6% yield. This means that our 4% CAGR total return breaks down as 6.6% yield plus *-2.6%* (negative) price per year. So even if utility stocks continue to perform well, remain in a bull market, the ZWU share price is expected to fall by about 2.6% per year. Which is more or less what it's done since inception, as you can see in the chart.

For people getting the big distribution cashflow this may not sound like a bad tradeoff, but I think I would worry about sequence of return risk. Utilities won't just smoothly go up over time. In a bear market with depressed prices, that distribution will *really* deplete capital. Note that capital is eroding by 2.6% per year during good years. It would erode at a faster pace during bad years due to forced withdrawals at depressed prices.

** But why would anyone choose ZWU over ZUT? **

Using the same assumptions above, you could invest in ZUT and forget about covered calls. Now you get 6% CAGR total return. You can sell shares to generate the same 6.6% cashflow, and your portfolio $ value will only erode 0.6% per year... barely perceptible. This gives you the additional flexibility to _choose_ to sell less during bad years, minimizing sequence of return risk, which will better preserve capital.

To me, it's amazing that someone would pick ZWU over ZUT. Even a retiree who wants the cashflow is far better off selling ZUT shares annually. This will feel like "capital erosion" to them, but the irony is: ZWU actually erodes their capital more due to that horrendous 2% CAGR performance drag.

Then again, if you continue this line of thinking, there's no reason to focus on high yielding utilities at all. A well diversified portfolio combining various stocks & bonds (say a balanced fund) is a more reliable way to generate the same 6% CAGR, without sector concentration risk. And now you can sell shares to your heart's desire.


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## james4beach (Nov 15, 2012)

I know that was a long post. But, a postscript: I think this is an illustration of why these dividend vs total return discussions aren't just a matter of personal tastes and preferences. There are real world consequences here including threats to retirees' capital sustainability. Paying the 2% CAGR performance drag purely for automatic distributions cannot possibly be in the investor's best interest.

https://business.financialpost.com/...t-you-from-overall-returns-even-in-retirement


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## OptsyEagle (Nov 29, 2009)

There should be periods of time where one will outperform the other. A covered call strategy works best in a sideways market. It loses a little less in a down market, so I suspect that is the next best for them. In a market where the upward move is fairly quick, like it has been for dividend stocks in the last 4 to 6 months, the covered call strategy will underperform, since the stocks inside get called away and their additional performance will go to the call buyer.


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## james4beach (Nov 15, 2012)

That's true, the strategy does work best in a sideways market where there aren't large gains. I found one period like this in the ZUT / ZWU history. The green line is ZWU covered calls, black is the underlying ZUT: http://schrts.co/cyfXWMHw

This is encouraging. For this 4 year sideways period, the two had about the same total return and ZWU outperformed for a period there as well.

We'd have to have more bull & bear phases and more years of results to know whether ZWU offers a good return in the long term.


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## james4beach (Nov 15, 2012)

Wait a minute. Regarding that sideways period, http://schrts.co/cyfXWMHw

If ZWU just matches ZUT performance during "bad" periods, but trails performance by a whopping 2% CAGR in "good" periods, then isn't it guaranteed to perform worse than the sector overall?

I still don't see the benefit of BMO's covered call ETFs versus holding the direct sector ETF and selling shares.


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## OptsyEagle (Nov 29, 2009)

I always call covered call ETFs a "mistake waiting to be realized". It was just my suspicion and perhaps I will be proved wrong but in my opinion, options need to be either managed or avoided. Preferably avoided but that is a personal thing. In any case, passive options will not work overly well, in my opinion.


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## humble_pie (Jun 7, 2009)

options can be well managed, but the covered call investment products - including ETFs - that i've looked at are not well managed. Those "managers" must be kids straight out of finance school w lots of bookish theoretical knowledge but not enough experience.

the mistake they keep making is selling options with strikes that are too close to the money. In a rising market - which we've had for more than a decade now - too many assignments will occur.

the managers, by their legal structure, are then obliged to buy back the exact same shares but at higher prices. inevitably this means the re-purchase of fewer shares. in rising markets, capital is thus constantly eroded.

before long, the total return of such a CC etf will lag its plain vanilla zero-option twin.

the managers could, of course, switch to selling calls with higher strikes, in order to forestall assignments. But higher strike calls have lower premiums, so the managers will never adopt this strategy. The managers know very well that investors are attracted to their CC funds strictly because of the high current yields they can deliver; managers know equally well that investors are not paying much attention to sub-performance when it comes to total return.

ironically, if we are in for a bear market, this could be a time when standard CC funds might outperform their plain vanilla twins with no options. The reason for this relatively benign state of affairs is that the number of assignments wlll dwindle.

on the other hand, disaster can lurk if the market price of a CC holding plunges below its cost. As mentioned, the standard "professional" manager will go right on selling calls with strikes that are too close to the money. When - inevitably - markets recover from bear market lows, the floods of assignments will start up all over again & the managers will find themselves surrendering good stock at loss prices because assigned.

there are plenty of useful option strategies that can be managed well. But this thread is dedicated to ETFs utllizing covered calls, so it's not quite the right framework for a discussion about prudent option strategies that work well over the long term.


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## undersc0re (Oct 7, 2017)

Very informative, enjoyed your discussion here! Thanks.


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## doctrine (Sep 30, 2011)

I have yet to see any option ETF strategy outperforming in anything beyond a short time frame. It sounds good, but I would guess there are also professional options traders who are taking advantage of these ETFs because of their rather obvious mandate. I do plenty well owning the utilities and banks directly.


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## james4beach (Nov 15, 2012)

Thanks humble_pie for the notes on the covered call strategy. Very interesting.


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## humble_pie (Jun 7, 2009)

doctrine said:


> I have yet to see any option ETF strategy outperforming in anything beyond a short time frame.



it's never a question of what option strategies one has "seen." There are plenty of strategies set forth in the textbooks & they all look convincing when "seen" by a casual reader or even by a serious student.

it's a question of what option strategies one has "worked." Worked repeatedly from beginning to end, including some windings-up that were unpredictable. This is a domain where experience helps. Eventually, selling volatility does come to improve returns slightly, over long periods of time.


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## humble_pie (Jun 7, 2009)

james4beach said:


> Thanks humble_pie for the notes on the covered call strategy. Very interesting.




jas4 i was thinking about you after you said the other day that you had always lost money with options.

this sad result suggested to me that you must have always bought plain calls, or possibly plain puts if you were feeling bearish. But one of the cardinal rules is that it's the sellers of options who make $$ while the buyers of options are usually the speculators who lose $$.

consider a call buy because one is feeling bullish. This is the classic speculative trade. But IMHO it's equally bullish while more productive to sell puts instead. The former strategy will drain cash _out of_ the account while the latter will inject new cash _into_ the account. So already there is an important benefit.

it's true the risk profile in a naked put is slightly higher, but nothing as alarming as inexperienced critics would have it. Risk is classically managed by selling puts in volatile stocks with strike prices that are significantly out of the money. This gives the option seller plenty of room to manoeuvre if his chosen option does not work out as he expected.

the other part of this same strategy is to anticipate well & act early to correct/protect one's position if one sees new factors developing in the wrong direction. For example i have short puts in AAPL. A few weeks ago i rolled them forward in time plus down 2 increments, from $140 to $130, because of the continuing US trade loggerhead with china. The exchange was still a credit spread, i collected a welcome $610 for my four minute activity.


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## james4beach (Nov 15, 2012)

It's true. I was going long puts and calls (pure speculation) and pretty consistently lost money over time.

My biggest mistake in my early years of investing was too much ad hoc activity. Over the years I have focused much more on methodology. These days, I follow well-defined strategies and stick with my plans. Options don't fit into any of my strategies, because I found other things that I am good at, but I always admire the people who can do well with options.

I also worked for a few years at a chip making company which was developing custom microchips for Goldman Sachs. One of the microchips was specifically for options calculations! This gave me a sense of how advanced the experts are, or in other words, who you're sitting down at the poker table with. Since then I've tried to be careful to only sit down at poker tables where I might stand a chance of winning.


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## humble_pie (Jun 7, 2009)

i'm not sitting at any poker tables with any advanced options experts though. They are the guys doing the quadruple flies & condors, you'll remember how metatheta & atrp2docbiz did those, avrex & lephturn were pretty good w the advanced stuff too.

me i just bumble along doing medium easy options pairs, very rarely triples. I cannot get my head around the dynamics of a four-legged option position, therefore i never go there. I can grasp the skews created by a pair of sequential numbers & sort of grasp how 3 moving number series are able to intercept each other. But 4 numbers reportedly all interacting & i am a total blank.


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