# Covered Call ETFs - ZWB, HEX, etc.



## avrex

The current high yield of ZWB is bound to generate some interest among income seekers.

With this hightened interest, will come questions on this new and unique product. This thread will cover these new income generators, including:




ZWB - BMO Covered Call Canadian Banks ETF (MER 0.65%)


HEX - Horizons AlphaPro Enhanced Income Equity ETF (MER 0.65%)

We'll follow their progress and question the risks and taxation implications.

.


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## avrex

*humble_pie thoughts*

I didn't want to lose some early thoughts/research that humble_pie has provided.

So I've taken his quotes from two other seperate threads and merged them into this thread.



humble_pie said:


> zwb is an interesting new creature with a high yield currently around 9.5%, payable in monthly distributions.
> 
> one highly evident caution is that the market value of the underlying banks could go down, and it would be expected that in such a scenario this fund would go down harder.
> 
> a less evident caution is that the taxation of this lucrative 9.5% yield is not yet known, the fund being too new (inception early 2011) and having not obtained any advance ruling from the CRA.
> 
> in the best of all possible worlds, income from a long-bank-short-call portfolio strategy will flow directly to an individual investor as a desirable combination of eligible canadian dividends plus even more desirable capital gains.
> 
> however, we do not yet know how zwb will distribute its income for taxation in its unitholders' hands. It is theoretically possible that the flow of option income will, through the intervening mechanism of the trust, be transmogrified into ordinary income rather than capital gains. This would be most unfortunate.
> 
> a further investigation could be justified. I might look into this myself. Presumably bmo etf fund management does hold an opinion on how it intends to classify its distrib for tax purposes in the first batch of T3s for this new fund that will be sent out one year from today.
> 
> meanwhile, in a worst case scenario, the most dire taxation consequence would be that both dividends & capital gains will morph into 100% taxable other income. At 9% or better, even this is not a bad deal, provided one is happy staying long canadian banks.





humble_pie said:


> there are broad general "extra tax implications" inasmuch as all income is, alas, going to be taxed.
> 
> zwb, bmo's bank covered call option etf, is so new that there is not much hard info. However the pie has been able to determine that bmo intends to pay distributions in the form of 1) eligible dividends as the greater part, and 2) capital gains in the form of ordinary capital gains plus return of capital, which is a form of delayed capital gains since ROC is used to adjust a cost base downwards.
> 
> the above are tax-favoured forms of income. For taxable investors these are more beneficial than straight interest, other income or foreign non-business income.
> 
> yield on this etf as of yesterday was 9.50%. There are other products utilizing a strategy of high dividend payors combined w short option selling. However, the bmo product has the simplest structure of any the pie has seen to date. Moreover, bmo is not over-paying its distribution imho, as some of the existing products are doing, esp dividend 15 with its split structure, which forces the issuer to raise new capital from time to time in order to support a somewhat outrageous dividend on the common series.
> 
> lastly - perhaps most interestingly of all - there would be a way to collarize this etf so as to produce a guaranteed return of approximately 3.40-3.50% per annum. In other words, a far better return than any HISA available in canada; and this in the form of tax-favoured income rather than straight interest to boot. Collarization will not be perfect in the sense that there are no options available for exactly this deliverable; however buying puts on a similar product would produce an adequate collar.


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## Causalien

Call option premium for Canadian banks are so little due to the effect of dividend and the fact that implied volatility for Canadian banks are close to nothing, that I do not think this is any different from outright holding the bank's stock.

Take TD for example. My stock price for that bank has doubled. Whereas if I have sold a covered call, I might have limited my upside while gathering little to no premium. If the stock were to fall down two strike prices, because of the thin premium, the Covered call fund suffers the same amount of downside as my actual stock holdings.

In writing options, the experience of the fund manager at writing options is a major factor of whether or not the fund meets expectation.


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## humble_pie

cause i understand your views but do not agree. In your 1st paragraph you say the new fund is no "different from outright holding the bank's stock."

here i disagree. The bmo fund's return is double that of the average dividend or more. To equal, bank stocks would have to continue to appreciate by at least 4-5% per annum, year after year. No certainty of this whatsoever.

like any long-bank-short-call position, the bmo strategy will return approximately 9-9.5% per annum in 3 out of 5 markets, and thus it will better a plain stock position. The 3 are stable (unchanging) markets, moderately falling or moderately rising markets. Plain stock will suffer, compared to an optioned position, in stable or falling markets; and may not rise as much as the option return will offer during moderately rising markets.

turning now to the 2 much rarer & extreme scenarios, an option strategy will not do any worse than plain stock in a market collapse; while it will equal or very slightly underperform plain stock in a fiercely strong bull market, the kind we might see only once a decade or less.

with odds like that, and viewed from the perspective of a decade or more, the option strategy is more appealing imho.

specifically, the bmo strategy is not quite the strategy that i favour or practice myself. I tend to sell less aggressive options, ie farther OTM. This means 1) my current cash return is slightly less than than bmo's; 2) my risk of assignment is less than bmo's; and 3) my participation in rising markets is greater. Another way of analyzing this is to say that my current return includes less actual or realized capital gains (lower option premiums) while deferring more notional or paper capital gains into the future.

the bmo approach means selling calls that are closer to the money. These bring in more cash, which is what appeals to investors. The ATM premiums also trigger more frequent assignments.

turning now to your TD example, the doubling in this stock occurred relatively slowly, over a fairly long period, which was the past 2 years. Yes i've held td throughout. Yes my stock has doubled. No i've never been assigned. What i did was adjust my options judiciously, from time to time, as the months & years passed. In short, i held & still hold a stock that has doubled, i've collected the dividends & i've also collected premiums from selling a succession of calls along the way.

a relatively inexperienced option trader often assumes that he is locked into exercise if he writes a call & the stock rises. In reality, however, he will have many opportunities to adjust his position, to dance with the market.

it's true that canadian bank options are slow, stout & ponderous dance partners. But what can one do. It's either dance with the dowagers or head south to look for the nubile young things. And i belong to the school that says rich dowager aunts like canadian banks are a mainstay in every canadian investor's family.


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## webber22

This was taken from Berman's call on BNN Feb 28, 2011:

_Since Jan 31, a few options expired worthless and they took in some premium. At this point they are writing calls that are about 5% out of the money and for only 50% of the portfolio. The ZEB holding is about 50% of the portfolio. It is their own equal weight bank ETF. They are looking to list options on this part too at some point. At the current level of implied volatility, at about 5% out of the money for 1-2 months, they can take in about 0.75% if they are good at witting of the offer side. The bid offer spread on such options can be extremely expensive. So if the basket of bank stocks on an equal weighted basis generates about a 3.5% dividend today, they need to write 3.5%-4.5% in option premium per year to keep the payout. Bottom line, it is quite achievable.

Where these strategies underperform is in a run-a-way bull market as cost of replacing stocks called away are higher than buy and hold. Odds of a run-a-way bull in the next few years is looooowwww! It can also be tough in rapidly falling bear markets like 2008 and 2009, when volatility is exceptionally high. Option premiums are higher to be sure, but timing is extremely difficult. Bottom line, it is a nice holding to diversify a yield oriented portfolio. I will be using it for my clients._


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## humble_pie

para 2 of the above is my point exactly. Only in a fiercely soaring bull market does the long-bank-short-call strategy somewhat underperform holding plain stock; and markets like these happen less often than once a decade. I would not describe the slow & steady rise from 2009 as being anywhere near this category.

in other markets long-bank-short-call outperforms.

to achieve the payout bmo is aiming for, the managers will definitely have to write calls on the equal weight bank etf that forms about half of ZWB's portfolio. In a rash of assignments this etf could be unbundled, although imho this should not be necessary, since synthetic stock positions could & should also be kept in place, at least to a certain extent.

btw nobody has mentioned the bull in the china shop yet. What-if-disaster-prevails-&-all-the-banks-cut-their-dividends. And-in-such-a-scenario-option-premiums-will-plummet. Mind you, plain vanilla bank holders would also be pulverized ...


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## J3ff

*Great post!*

Great post Humble Pie and Avrex. It looks like the markets going forward will be range bound and thus, the ZWB and HEX will both perform admirably - especially if it's yield you're seeking.

I think I'll add positions in my portfolio.


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## lefilter

Very interesting information here, thanks.

About the small liquidity and vol of the canadian option market, how will the rising popularity of those covered call ETF affect the premium collected? I would think the sudden excessive offer in call writting will quickly reduce the expected yield on these ETF, but im no option expert.

How about a TFSA Drip on HEX for low maintenance long-term strategy?


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## humble_pie

good idea ... but i for one don't think there will be any sudden excessive offers in bank calls.

if one looks through open interests on mx-ca, one finds high volumes in a restricted number of underlyings. Banks are among these. Others are xiu, xeg, xfn, sometimes xgd. 

these spotty cases of high open interest indicate that institutions have taken/are taking these positions. It's been going on like that for years. So i don't believe that the addition of bmo's new etf as a seller of options is really going to put any dent in proceedings at mx-ca.

on the contrary, more liquidity should mean better spreads for us small fry.


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## Argonaut

The ultimate yield play would be to write covered calls on this ETF. I doubt there's a market for it, though. This is why we need mergers like the LSE-TSX to happen.. more liquidity.


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## avrex

Argonaut said:


> The ultimate yield play would be to write covered calls on this ETF.


A covered call within a covered call, ... Inception.


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## andrewf

I doubt covered calls on this ETF would be all that lucrative. It should be a fair bit less volatile than the underlying securities.


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## gibor365

J3ff said:


> Great post Humble Pie and Avrex. It looks like the markets going forward will be range bound and thus, the ZWB and HEX will both perform admirably - especially if it's yield you're seeking.
> 
> I think I'll add positions in my portfolio.


I bought ZWB 2 weeks after it got launched and very happy with it. I also long on BMO and RY, but so far ZWB (considering huge monthly dividends = nice compounding) is much better. 
In a very bulish market probably banks' stocks will outperform ZWB, but in moderate bullish or moderate bear markets - ZWB should perform better


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## Causalien

avrex said:


> A covered call within a covered call, ... Inception.


Disclaimer: I hold BMO and TD and a variety of US banks + preferred.


Write VXX call options = mindfuck. Derivative of a derivative of a derivative.

Humble_Pie, the upside is not what I am worried about. It's the risk of a downside. From my point of view, the risk = same as stock. Whereas rewards is mediocre. It sounds like it's being marketed as a safe income generating ETF, maybe one day it'll be as safe as ABS back in 2007. When I want income generating securities with low return, I don't want it to have stock like risk. 

The trashing of this strategy is also because I am bearish CDN banks from now on. Until the Real estate market actually corrects and finish correcting and we go back to a normal economy where interest rates are not close to zero, I do not believe in the sustainability of bank's income at this level. 

I also need to see that the CMHC 5% float can actually withstand the defaults to come and that it will not spill over to the banks. Once those events pass, I will believe in this strategy as an income generating fund.


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## humble_pie

cause you say you are "worried" about ZWB plus you are "bearish cdn banks from now on" plus you don't believe in the sustainability of banks' income. Won't you please now tell us why you are holding bmo, td, a variety of US banks & their preferreds.

furthermore, what is this "rewards is mediocre [sic]" & this "low return" in zwb that you are complaining about. If 9.5% in tax-advantaged income from a top grade base is mediocre or low for you, i do beg of you to tell us about the supernovae better income returns that you are finding for yourself.

yes this etf does present the risk of the canadian banking sector. For investors who have already accepted that risk, it offers another choice.


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## lefilter

I think Cause meant the upside of ZWB is heavily capped because of the calls sold. The risk profile is about the same, so that makes the risk/return hard to evaluate.

Too bad there is not enough history in ZWB to see how it performs against something like XFN. I would like to know the effect of the covered callls on the price return. (how much your giving up to get better yeild). Hopefully its not much for a long horizon. Does the fin. sector usually advances with big one time returns like when a bank beats the estimates? If this is the case (i dont think so), maybe the cap will cut too much return.


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## Causalien

lefilter said:


> I think Cause meant the upside of ZWB is heavily capped because of the calls sold. The risk profile is about the same, so that makes the risk/return hard to evaluate.
> 
> Too bad there is not enough history in ZWB to see how it performs against something like XFN. I would like to know the effect of the covered callls on the price return. (how much your giving up to get better yeild). Hopefully its not much for a long horizon. Does the fin. sector usually advances with big one time returns like when a bank beats the estimates? If this is the case (i dont think so), maybe the cap will cut too much return.


Like leftier said, the upside is capped and the downside is the same as stocks. 

Holding BMO and TD doesn't mean I am bullish banks. I am riding the last of its wave until certain event happens or the trailing stop loss triggers at 5% at the moment. I've been holding BMO and TD since 2008. The fact that I have this order in place ever tighter now means I am getting out, but I also understand that I need to ride my winners.

As for US banks, they have already gotten through most of the housing down turn. CDn banks did not. From the fundamental perspective, we levered up while US levered down. Even in my buying of CDN banks, I chose the two with most US exposure. One leader and one dog. 

In any case, we both have different beliefs about the fate of CDN banks. Time will tell. Preferably this year we should see how the interest rate change will affect bank earnings.


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## humble_pie

speaking of riding bank winners, then why not get into zwb for one or 2 more divs. Really does make the same sense.

& how about rewards-is-mediocre-[sic]-low-returns. What, you don't want to tell us about your own glorious north-of-9% returns from income holdings that are so much better ?

plus this etf is not capped on the upside. Cause you should know better than that. This idea comes from novice option players who think one ITM call means sudden death, game over, rigor mortis.

in reality the managers of both zwb & hex will keep on dancing continuously. Broadly speaking they'll put on new positions. It will be likely that long before any option expires the managers will have a counter-position or counter-positions in place. If the bank sector rises, for example, zwb will rise also, in countless steps that will each be so tiny they will not be noticeable. As already noted (many times) the only scenario in which plain stock will outperform is a suddenly soaring bull market.

the HEX prospectus shows that manager has huge discretion to put on naked & unlisted option positions. These permit the mgr to continually adjust his options. Haven't checked bmo prospectus but would assume it carves out similar freedoms for bmo managers. Dance on.


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## lefilter

Thanks hp. I will probably ginea pig this one for you guys in my TFSA and try to keep you posted. My TSFA is not large enough yet to cover call myself.


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## gibor365

lefilter said:


> I think Cause meant the upside of ZWB is heavily capped because of the calls sold. The risk profile is about the same, so that makes the risk/return hard to evaluate.
> 
> Too bad there is not enough history in ZWB to see how it performs against something like XFN. I would like to know the effect of the covered callls on the price return. (how much your giving up to get better yeild). Hopefully its not much for a long horizon. Does the fin. sector usually advances with big one time returns like when a bank beats the estimates? If this is the case (i dont think so), maybe the cap will cut too much return.


I bought today another piece of ZWB... yes, we don't know history about ZWB, but for example today all 5 big Canadian banks were down on average of 0.3% and ZWB was flat. From my tracking ZWB perform better if there are modest decline/increase in bank stocks. 
Another advantage - if you hold 1-2 banks (btw I hold RY and BMO separately) and this bank goes down, it doesn't mean ZWB goes down too


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## gibor365

From inception date ZWB outperforming XFN and has dividend more than 3 times hire


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## HaroldCrump

I have been "watching" ZWB for a few weeks now.
Can anyone explain why the unit price does not change with the change in the underlying bank stocks?
The fund holds each of the individual banks that it writes the calls on, correct?
If so, why doesn't the share price move?
It's been sitting ~ at $16.47 for days and days.
It's almost like it's tied to the yield % and unless the yield changes, the unit price won't.
What am I missing?


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## al42

Down at $15.93 today.


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## webber22

It went down today because it's the ex-dividend date.

You must be using Google finance if you see it stuck at 16.47. There's been problems with some etf quotes in that system


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## HaroldCrump

webber22 said:


> You must be using Google finance if you see it stuck at 16.47. There's been problems with some etf quotes in that system


Yes I am...hmm...what's the problem with Google?
I had heard something about Claymore ETF quotes not showing up correctly on Google, but is it all ETFs?


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## Lephturn

It's trading around a bit today.

Open	$16.04 Previous Close	$15.91

Today's Range	$16.04 - $15.90
Net Asset Value (3/31/11)	$16.26	
52 Week Range	$15.34 - $16.74
Dividend Yield	9.50%


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## andrewf

HaroldCrump said:


> Yes I am...hmm...what's the problem with Google?
> I had heard something about Claymore ETF quotes not showing up correctly on Google, but is it all ETFs?


Claymore and Horizon are apparently having a 'disagreement' with Google. I suspect is has something to do with a crackdown on reporting (by what, the OSC?) in terms of reporting performance of funds with less than a year of history.


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## I'm Howard

*ZWB Interesting ETF*

ZWB Pays about 9%


The downside risk is if the banks are:
if they (bank stocks) perform very strongly, the call options will be exercised. The result will be having to buy back the stock and result in a slightly lower payout - more than half is income from call options. The downside risk is less than that of owning a regular banks etf. In neutral, normal bull (slightly upward) and bear markets the covered calls will be maximized. In essence, you're not making as much as you normally would if the underlying equities skyrocket. If the banks tank, you'll still get roughly 9.5% covered call income (instead of the 4% or so of the regular banks dividend) but the equities will still go down. Hope this helps.


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## webber22

This has already been discussed here and a new article came out this week.

I'm not buying into this until I see the year-end tax forms to see the allocation of dividends, capital gains, etc.


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## I'm Howard

Thanks for the link, and I did buy a 1,000 shares with some cash that was non productive, the yield is too good and is a nice adjunct to JNK.

I personally like covered Call Writing, it does limit the upside but also reduces the downside.


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## gibor365

webber22 said:


> This has already been discussed here and a new article came out this week.
> 
> I'm not buying into this until I see the year-end tax forms to see the allocation of dividends, capital gains, etc.


 than buy in in registered account or TFSA.... I did and I don't care about dividend allocation
.
_I did buy a 1,000 shares _ niece  I have a little bit more than 500 shares and every month 4 shares get DRIPed


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## gibor365

Horizons announced 2nd monthly dividend for HEX - $0.12743 that about 15% yield - not bad


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## houska

Interesting new product and I'm happy it's out there. That being said, my pea brain is struggling a bit who the target audience really is...

If I understand right, a covered call strategy pays off in a sideways or in a not crazily volatile market (when it behaves like an income instrument). It slightly reduces losses in a downmarket (via the option premium received) and caps gains in an up market (due to the options being exercised or financial equivalent). 

So I get that there is a niche which is investors wanting to make a bet that the market (or the Canadian financial sector) will go sideways. This is a market timing bet. 

But for the long term bull, at best you will have some frictional losses from expense drag (if the market is indeed perfect..). For the bear, it doesn't much protect. And for the skittish volatility avoider, why is it better than an x% income, y% pure equities allocation? Sure it would not be easy to get a 9% yield from a mixture of equity dividends and income instruments, but that is presumably the reward you get for taking on incrementally larger downside risk.

Don't get me wrong. I understand the logic of writing covered calls on stocks you own (when you are making a specific bet on the behaviour - or nonbehaviour - of a specific company you believe you understand) though it does not make sense for my personal investment strategy. But a covered call strategy on an index / market / broad segment seems a bit of a strange bet to make - it's like an equity investment in a down market and an income investment in an up market, and all somewhat opaque since it depends on the specific nature and timing of the options the manager chooses to write.

OK - rant off. I'm actually not *that* negative on it, but am really curious what is the real market for this - and whether it's a good market for it or whether it's success depends on being misinterpreted as a reduced risk product, which in my opinion it is not.


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## I'm Howard

Covered Calls make sense in a volatile market and in one where Rates are going up, the Call Premium gets larger.


I am a firm believer in options, they are seen as risky by the novice, the opposite is true...

I have added both of these but , like other asset classes, I limit my exposure to no more than 10%.


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## bmckay

For anyone who owns HEX...

Have you received your May distribution or DRIP?

It was announced that it would be paid on or before June 10 but it has not yet been paid to me. What is going on?


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## gibor365

bmckay said:


> For anyone who owns HEX...
> 
> Have you received your May distribution or DRIP?
> 
> It was announced that it would be paid on or before June 10 but it has not yet been paid to me. What is going on?


I also didn't get... but don't worry, last month I got them about 2 weeks later...same story with ZWB


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## peterk

Bear with me through some potentially stupid questions, as I don't know squat about options...yet. The banks are yielding ~4%, ZWB is yielding 10% So does selling options really produce an income of 6%? That's seems high, but then I don't know anything about it. HEX is even worse. It's cumulative div yield on it's holding is probably only 2% (guess) yet it's yelding 15. How do you make 13% from selling calls? Furthermore, if these numbers are attainable through selling calls, how come zwb makes 6% selling calls but HEX makes more than double from selling calls?


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## MoreMiles

peterk said:


> Bear with me through some potentially stupid questions, as I don't know squat about options...yet. The banks are yielding ~4%, ZWB is yielding 10% So does selling options really produce an income of 6%? That's seems high, but then I don't know anything about it. HEX is even worse. It's cumulative div yield on it's holding is probably only 2% (guess) yet it's yelding 15. How do you make 13% from selling calls? Furthermore, if these numbers are attainable through selling calls, how come zwb makes 6% selling calls but HEX makes more than double from selling calls?


Option can be played very easily or complicatedly... depending on your expertise level. Some option strategists use different options together to limit risk... (eg, collar, butterfly, etc) Like all investment, it's about risks and profits. The higher risk you take, the higher the reward.

You can aim for 15% profit but the risk is that you can lose your stocks (ie, get called away).

HEX is new... I have noticed that it does not follow TSX very well. So it's not really true that they will always give you that extra yield on top of TSX equity gain. Look at today (June 16), XIU is down 0.68% but HEX is down 1.17%... so it's 0.5% extra... After a few times, you have a nice 5% extra, so it gives you that impression of making 5% more than others. That is just my opinion. The ETF is too new to have any verifiable track record yet.


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## humble_pie

no one can answer your questions because no one knows what, exactly, the options fund managers are doing. And no one is going to have a real clue until the first audited full statements come out - possibly not before 2012 - and all positions are revealed.

one should also keep in mind that the fund managers are permitted by their prospectuses to hold derivatives, futures and puts as well as both long & short stock positions. It is highly unlikely that they will adhere to a simple loosie goosie long-stock-short-call strategy at all times.

even with the publication of the first audited complete figures, the picture will not be perfectly accurate, because the managers will have closed out the more alarming-looking positions & they will be back into conventional long-stock-short-call configurations when the time comes to have the full frontal photo taken for the auditors.

can the funds earn the payouts they've been distributing ? yes, certainly. They may not be able to keep it up. They may be selling more aggressively now, in the early weeks & months, so as to begin with a hi-paying record & thus attract more business to the fledgling funds.

as it happens i practice a related strategy that is more suitable for retail investors imho. The options i sell are farther out of the money and also farther out in time. I also sell otm puts. Such a portfolio is less active, which translates into a savings of time, effort & commissions for the retail investor. I roll all my positions forward as skilfully as i can, or else i close them out, with the result that i am never assigned. The option income is roughly equal to dividend income, but it's even more favourably taxed.

you mentioned the low dividend amounts of the individual holdings within the HEX fund. You say you are puzzled that the distribution is greater than for the bank fund. This is because option premiums for many of the HEX holdings are significantly higher than are premiums for the dear old, dull old canadian bank shares on the montreal exchange. All HEX options are sold in US markets.

a high premium example would be CNQ options. The US july 40 call closed today at 1.10 bid, for example. The manager who can keep selling a CNQ near call 9 or 10 times a year might collect roughly 10.00, for a return of roughly 25% from the sale of call options alone ...


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## peterk

Ok - so it's fact that the HEX basket of stocks has a higher volitility than ZWB ones, and the options therefore command a higher premium? If the market rebounds I'll be looking into selling calls against some of my positions, but I really don't know much about options yet. Perhaps I'll look at these etfs though.

Second question, among many I'm sure, since an option premium is set based on volatility and market conditions, won't there be a natural tendency to break even over the long term? No one will buy an option if they think they'll lose money, and no one will sell an option if they think they'll lose money. So isn't selling options really for people who "think they know better" than the market?
No jabs meant to any traders out there - I'm a buy and hold guy who firmly believes trying to time the market will get you nowhere, and am just trying to see if it makes sense for me to use options or not. Could you reccomend a good resourse to learn more about them?


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## I'm Howard

C.B.O.E.

Thomsett,Undertanding Options.

FORGET the CDN Options Market, stay with US ,KEEP IT SIMPLE, Covered Calls,


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## liquidfinance

So are people of the general opinion that ZWB is a god investment with a yield which is sustainable?


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## andrewf

ZWB isn't bad, but don't expect serious outperformance here.


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## liquidfinance

andrewf said:


> ZWB isn't bad, but don't expect serious outperformance here.


I had my eye on it when it was listed in BMO just before lunch. I think at launch they listed it to have an 8.5% yield. With the banks it was holding I was quite sceptical at first and was wondering to see how the yield would pan out. With an almost 10% yield you don't really need to outperform so long as the yield is sustainable. 

I still need to do more research as to how covered calls work which is why I thought that this would be a safer play.


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## humble_pie

lol & who is expecting serious outperformance from bank stocks ...


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## andrewf

I mean that I would expect the fund to lose value over time in order to keep that yield. Little slips here and there... Otherwise, the obvious move is a long-short trade where you go long this fund and short a straight bank equity fund without the covered call writing. There's no free lunch.


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## humble_pie

woo-hoo tell us more.

gotta love these opinions & prognostications from folks who don't do options.

please tell us about those little slips, they will constitute a downward line to zero in how many years ?

(signed)
arty right-brained strawberry tart


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## andrewf

I'm not predicting it will go to zero. I expect it to underperform a pure equity position because at some point they will either be assigned or have to buy back an option for more than they paid for it.

On a total return basis, I expect them to be about the same, perhaps ZWB slightly outperforming.


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## humble_pie

on a drip plan basis - ie w all distributions reinvested in new units - keep in mind that zwb has bigger distrib, therefore permits more units, therefore receives correspondingly larger distrib the following month, rinse & repeat - on a drip plan basis the 2 funds zwb & zeb are running neck & neck as of friday's closing prices.

folks who invested 10,000 in zwb on the day it debuted in early february & who dripped now hold an asset worth 10,193.38.

& folks who invested 10,000 in zeb on same day & who dripped now hold an asset worth 10,193.05.

markets & bank stocks have been falling. Were they to reverse, the extra leverage in zwb would push that fund slightly further ahead imho.

as for "at some point they will either be assigned or have to buy back an option for more than they paid for it," a remark like this is a sure sign of an option novice.

this remark is not true in the least. If markets churn or drop as they are dropping now, the option manager never has to buy back his position. In a falling market, he can even leave it naked & sell another call at a lower strike.

only in a fairly sharply rising market will the manager buy back his position. And always, without exception, he will simultaneously sell another forward position, sometimes 2 positions. In most cases these are done as credit spreads. They are rarely carried out during the few days preceding assignment. Usually, the option manager is long gone from his risk position before assignment date.

the skill of an option manager is not in choosing which option to sell in the first place. There are plenty of programs that tell any amateur how to do that. The skill lies in knowing how to trade profitably through all the little dates & events that happen during the life of an option. At times the manager may even move, briefly, into a short or synthetic stock position.

one thing the skilled option manager will never do is sit there like a bump on a log, waiting for an assignment to happen.

i for one am always surprised at the number of option critics - usually parties who never trade options - who are determined to believe that short sellers of options do nothing except sit there like bumps on logs.


----------



## andrewf

^Are you suggesting that a 'non-novice' option trader can never have a losing trade? Because this is my skeptical face.


----------



## humble_pie

it's always good to be skeptical in financial markets imo. Of course some options have to be bought back at a loss, ie a loss for that particular trade, although they usually can be profitably rolled forward.

operative word is "some." Many options simply expire because they are out of the money.

the only options at risk of assignment are those which are itm. The point i already mentioned is that the trader who is buying to close to prevent assignment will simultaneously sell other options, and usually this pair trade is a credit spread. There are several combos & variations of such pair trades.

most of the time this rollover can also be done to a higher strike price if desirable. Hint: do these on falling market days. The gamma & theta will hit the near option harder while tending to preserve the delta of the farther option.

in a recent interview the HEX fund manager told the journo that he expects 25% of his positions to be assigned. This figure is startlingly low imho.

since i have a different practice with less assignment risk, in my experience the assignment percentage is just above zero. Perhaps 2 or 3 per mil. So far in 2011 for example, i've had only one minor assignment. I knew it would occur, and did a few complicated things in advance, rescuing most of the position but deliberately leaving 400 shares for the dividend plucker to harvest.

imho non-options players are nearly always way too chuffed about assignment. The reality is that it rarely happens. Tradeking points out that only 17% of US open option contracts in 2006 were exercised. Tradeking got its figs from the options clearing corporation, so they're official.

in my own practice, i sell strangles that are farther out in time & farther away in strike price from the stock natural, than the calls sold by the bmo & hex managers. Most stocks trade in a band most of the time, so this means selling calls & puts near the edges of the band to speculators.

because of the wider trading band, there's more room for stocks to move either up or down before assignment bells will start to ring. Most of my sold options don't get assigned. Even if & when they become in-the-money, usually there's sufficient premium in the option bid price to prevent the counterparty from exercising. There are formulas to evaluate this premium. Dividend X dates have to be taken into account. I monitor these formulas & X dates very carefully.

i've never practiced the hex/bmo strategy, although many do. I did purchase a small position in both these funds out of curiosity, to see how they do compared to myself.


----------



## I'm Howard

humble-pie, the strategy you outlined would invove dealing in very large numbers of options, the premiums on the options you describe would be low, even more so with today's rates.


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## humble_pie

no, i believe you are thinking too far out of the money. This is not what i'm describing.

also, premium depends upon the underlying, as you know. Some with low iv, like bce or xiu, have little theoretical value in their premiums in any series or class. Others like US cnq, abx or pot have significant tv & therefore have hi-value premiums.


----------



## MoreMiles

I was thinking about this type of covered call ETF's.

Does this mean that the maximum gain is capped at 15% for HEX because it does not have the "half-ETF and half-covered call" approach like ZWB? Every stock holding in HEX is covered by the writing so it will get called away at 15%?

So is 15% a maximum gain (ie, funds get called away) or minimum gain (ie, distribution + fund appreciation)for this fund then?

Also, is 15% really sustainable? Or are they simply giving you "Return of Capital" so in a few years... the ETF runs out of capital and drops to $0?

Since I'm new to option trading, your help in explanation is greatly appreciated.


----------



## humble_pie

hello Miles re paragraph 2: no, and no.

para 3: no, and no.

para 4:

i personally don't think the 15% is sustainable but i could be wrong. The manager could have artificially pushed up initial distributions - in order to attract new business - by selling options father out in time. These would initially bring in higher premiums.

at the present time no one has any idea about the proportion of return-of-capital in the distribution.

i've posted several times that no one can peer inside the new option etfs to see what, exactly, the managers are doing;

and i've posted that the managers are empowered to hold an array of products both long & short including options, futures, other derivatives & common stock (notice please the possibility of short stock positions);

and that we will not really see anything until the first full set of 6-month figures are published;

and that even these figs won't give the true picture because the managers will window-dress for the occasion.

and i've posted that i purchased a small amount of hex & zwb - together less than 1% of total portfolio - in order to compare with my own results.

and i've posted about my own covered call strategy, which is quite different from the hex/bmo managers. It's ratio strangles with the number of puts sold being usually half that of calls or less. This may sound more perplexing, but in reality it's less hectic & therefore less work than the hex approach.


----------



## swabeyjw106

*ZWB Performance*

Here is a rough quick look at ZWB vs ZEB.

ZEB has out performed ZWB by about 3.5% Feb to July 2011 in price(NAV). 
ZWB has paid out about 4.2% on the $15.21 starting NAV. ZEB has paid out about 1.4% in distributions. 
On a distribution basis ZWB is up by 2.8%(4.2% - 1.4%). 

So if you held ZWB instead of ZEB you were short 3.5% - 2.8% = 0.7% on a cash out basis (assuming you could not reinvest the higher dividend to make up the loss). If you continue to hold ZWB you have a lower NAV (3.5%) going forward to earn return. 

The kicker is that the market was trending up for two months and trending down for the rest. My understanding of covered calls is that ZWB should have been out performing under these conditions. Although I'm sure the devil is in the details.

From looking at the trend in the difference between the price of the two ETFs, I can not identify where the increases occur, other than to say it does not seem to be a few events but a slow progression.

I do not care much about the details of how the return is achieved. I do care about the risk. For me the risk of ZWB vs ZEB is the friction losses in execution of a covered call operation.

For now I am staying on the sidelines with ZWB. It would be great to see the delta in NAV between ZEB and ZWB holding for move than a month or so. The basic idea of selling some upside for less risk on the downside and higher distributions in a sideways market is appealing.


----------



## CoveredCallETFs

humble_pie said:


> hello Miles re paragraph 2: no, and no.
> 
> para 3: no, and no.
> 
> para 4:
> 
> i personally don't think the 15% is sustainable but i could be wrong. The manager could have artificially pushed up initial distributions - in order to attract new business - by selling options father out in time. These would initially bring in higher premiums.
> 
> at the present time no one has any idea about the proportion of return-of-capital in the distribution.
> 
> i've posted several times that no one can peer inside the new option etfs to see what, exactly, the managers are doing;
> 
> and i've posted that the managers are empowered to hold an array of products both long & short including options, futures, other derivatives & common stock (notice please the possibility of short stock positions);
> 
> and that we will not really see anything until the first full set of 6-month figures are published;
> 
> and that even these figs won't give the true picture because the managers will window-dress for the occasion.
> 
> and i've posted that i purchased a small amount of hex & zwb - together less than 1% of total portfolio - in order to compare with my own results.
> 
> and i've posted about my own covered call strategy, which is quite different from the hex/bmo managers. It's ratio strangles with the number of puts sold being usually half that of calls or less. This may sound more perplexing, but in reality it's less hectic & therefore less work than the hex approach.



I think most of those points are valid and looking only at the dividend yield would certainly give a very incomplete view. However, when you combine the dividend yield and the return and compare that to a "standard ETF", you would get the complete picture.

If the manager does decide to pay higher dividends, it would be eating into the actual value of the fund (NAV) which will result into a lower return. So yes, that does make it possible to evaluate the manager without knowing how much of the distribution results from selling options, etc.

And as for doing it yourself... unless you have a lot of knowledge and a significant amount of money, the fees involved (both trading, spreads, etc) would be too much to overcome in my opinion...


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## wraphtor

*ZWB return of capital?*

Hello this my first post. I hold a bit of ZWB but I wonder about the composition of the distributions. If they can't under some market conditions generate enough premiums from writing the covered calls will they start returning capital to the unitholders by selling of equities? Have they done so yet? A lot of these covered call funds have blown up in the past.Thanks.


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## doctrine

Does anyone here hold HEX or ZWB and are pleased with it?

Looking at both charts, you would be in the hole certainly with any purchase before 8 Aug; ZWB's distribtion is down to $0.101 from $0.129 and HEX is down to $0.113 from an initial payment of $0.178 but more typical was $0.127 or so. 

Wondering if they'll steady out here but they've certainly not performed well at all. They may even be lagging owning the banks straight up, most banks are only down about 10% since April but ZWB seems to be down 20% on NAV but would make up some of the difference with higher distributions, but not all.


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## Homerhomer

Most interesting thread, just saying hello so I can find it easier later on ;-)


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## humble_pie

i bought small amounts of these 2 to see how they'd do when compared to my own efforts, which are also call & put selling but with different modalities. 

bref, for these boring old stocks i believe in sustainable organic harvesting, not at-the-money call selling. 

most good old stuff trades in a band. Two or 3 times a year, as regularly as spring follows winter & summer follows spring, the farmer reaps the current crop of otm calls & otm puts. As the trading band moves higher or lower, he might adjust his options to different strikes. Meanwhile he collects the dividends year-round.

it helps that he likes farming & gets his crops right for his soil & climate.

what these managers are doing with their atm calls is slash-and-burn. Huge amounts of roundup. Artificial applications of nitrogen, phosphate, potash. Everything algo driven. The result is soil depletion & eventually weaker crops.

all this has been discussed upthread.


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## HaroldCrump

doctrine said:


> They may even be lagging owning the banks straight up, most banks are only down about 10% since April but ZWB seems to be down 20% on NAV but would make up some of the difference with higher distributions, but not all.


ZWB compared with ZEB (not including distributions)


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## andrewf

Total return on ZWB since Feb 3 (reinvested distributions) was -9.5%. Same figure for ZEB is -10%. So ZWB isn't underperforming ZEB, but that difference in return is so small it's hard to say it is significant. Overall, though, the covered call ETFs are not really adding value during the time they are supposed to: in falling markets. When markets snap back, CC ETFs ought to underperform.


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## CanadianCapitalist

Ran a quick calculation.

ZWB total returns since inception: -4.6%
ZEB total returns in the same time frame: -5.0%

includes distributions but assuming distributions are not reinvested.


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## andrewf

How did you get that, CC? I used Yahoo Finance.


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## CanadianCapitalist

ZWB	ZEB
Start Price	15.21	17.19
End Price	13.53	15.98
Distributions	0.98	0.343
Returns	-0.046022354	-0.0504363


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## gibor365

CanadianCapitalist said:


> Ran a quick calculation.
> 
> ZWB total returns since inception: -4.6%
> ZEB total returns in the same time frame: -5.0%
> 
> includes distributions but assuming distributions are not reinvested.


So in case of reinvesting distributions ZWB did even better


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## andrewf

ZWB started at 14.96 in dividend adjusted terms on Feb 3 and ended Nov 1 at 13.54, giving 90.5% of original value, or a 9.5% loss. ZEB went from 17.77 to 15.98 for a decline of 10%. 

I was using month end dates, I think that accounts for our discrepancy. Through Nov 15, Yahoo Finance has -5.7% and -5.9% respectively for ZWB and ZEB with reinvested dividends. Hardly any difference in performance to speak of.


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## andrewf

gibor said:


> So in case of reinvesting distributions ZWB did even better


Actually, taking dividends in cash outperformed reinvesting dividends for both funds. They did fall in value after all.


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## humble_pie

suppose there would have been a 3rd portfolio running as an organic venture. A self-directed portfolio with no management fee. It holds the big 5 banks & sells otm call options.

its path on harold's chart would be slightly higher than ZEB (no management fee.) However its payout or yield would be roughly 170% the distribution of ZEB. One will note that its yield will be less than ZWB because it sells otm options, not atm options, therefore it is not cannabilizing itself.

in other words with a little bit of work many investors owning plain vanilla bank shares, or plain vanilla XIU-type top-30 stocks, can run their own covered call funds.

this is all that jc hood is doing when he swans around on bnn tv videos. Hoodie also makes mistakes - at least one every show - which betray that his options knowledge is on the mediocre side.

example of recent mistake: caller asked hoodie doodie if he could sell options in margin account against stock held long in registered account. The correct answer is that, yes, he certainly can. And not only can, but sometimes should, because of the greater option-trading flexibility that a margin account permits. (Investor can write naked calls when rolling his options, for example, which treasury department rules do not permit in a registered account.)

hoodie still can't get his brain around the idea of hedging through different accounts. He replied that brokerages won't allow this. But in fact brokerages do allow this. The practice is nothing more than running naked option positions in margin while covering them in registered. Any client with sufficient margin can do this. It's not an ace idea as a permanent strategy imho, but occasionally it has a useful place.

it's challenging to understand why anyone would pay hoodie or bmo funds or horizon funds to manage a simple option portfolio holding banks or other blue chips.


----------



## andrewf

^ In that case (and as you say), it is not a call option sold against the registered account holding, but a naked call that is hedged in the total portfolio. In a sense it is a covered call, but it is not covered from the perspective of your broker. Maybe that is what he meant--I didn't see the comment in question. From my understanding, this can cause some sticky tax issues if capital losses arise from the options trading in the non-registered account.

For everyone else's benefit, I gather the hoodie doodie you are referring to is Larry Berman. 

Are you saying this ETF would be more successful if it sold further OTM calls? What I recall the PM saying is that the calls are not ATM, but 1 or 2 standard deviations from the current price. I can't see what calls they are writing, so I can't comment.


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## HaroldCrump

andrewf said:


> I can't see what calls they are writing, so I can't comment.


They are listed on the list of holdings on the ETF's website.
The major positions, at least.
It keeps changing monthly as they roll over their positions.


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## humble_pie

the way i see it, there are only 2 principal methods to extract more than standard performance from a major index fund or from a group of its underlying stocks.

one method utilizes timing strategies. There are members of this forum who have developed expert techniques and who are successfully using vix or vix-cousin options as proxies.

the other method utilizes the selling of options against the index etf or against some or all of the actual stocks that comprise the index. As i recall the prospectus for hex, the managers intended to sell calls either atm or one strike above market, within a 60-day expiration time frame.

for several reasons, i don't do that. Just one reason is that, often, time decay has already eroded some or much of the premium as one gets down to the last days of an option's life. This fall it's happening early in roybank januaries, for example. Much of their premium is pfffft already. They are not worth selling. It's unusual, because normally roybank calls retain time value until the last 30 days.

instead i look among strike prices at least one or 2 strikes away & farther out in time. For example, i have a lonesome goog short put that i keep on selling, year after year. It's always many, many strikes below goog's market price. Recently i moved it up from short 450P to short june 475P, while goog rose from 500 to 600. Premiums for goog options are rich, so even at these strikes far below market i still take in 1500-2000 per annum for the lonesomes, which is not bad considering the original cost base was zero.


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## webber22

Looks like BMO has clarified the ZWB taxation 
_
These annual reinvested distributions generally represent realized capital gains within the ETFs or special dividends received by the ETFs.(2)

(2) Premium income as a result of covered call writing has been distributed monthly as a cash distribution. Premium income when distributed is treated as capital gains by investors._


----------



## dogcom

*Covered Call ETF's*

Is now the time to maybe own these ETF's if your opinion of the market is to go nowhere to down. You have ZWB, HEE, HEP, HEX, HEF and so on paying good dividends monthly. Of course the risk besides stocks going down like normal, or your stocks get taken from you when they rise enough in price.

Even though it seems if you want to hold something in the environment we are in then you may as well get paid for it.


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## dotnet_nerd

I'd like to see an ETF of covered-call ETFs. So I can write a covered-call on it


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## screwjack

dotnet_nerd said:


> I'd like to see an ETF of covered-call ETFs. So I can write a covered-call on it


A covered call strategy usually has a better sharpe ratio than the underlying, so I wonder how a covered call strategy on a covered call ETF performs.
Incidentally, a short straddle strategy has an even better sharpe ratio than a covered call strategy. (At least this is true for S&P and Nikkei.)


----------



## dogcom

That is an interesting twist and I am sure someone will probably come up with it.

I also forgot to mention the dividend yield moves around and is not set. Also I think the funds sometimes pay part of the dividend from the fund money itself or the money gets retired away somehow in the transactions. I am sure there is other stuff to mention and that is also what I am interested to hear about these products.


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## humble_pie

these funds including every aspects of their payouts have been done to death in countless threads. I know the search capability of this website is perhaps not the greatest but perhaps a newcomer to these funds can find some of the threads ...

i bought a tad each of zwb & hex to compare with my own strategy which is different from these fund managers. I'm disappointed in the funds. An investor can do better on his own. Nothing more to add.

i don't short straddles on hi-dividend stocks because there's always going to be a losing side which has to be repaired. The taxation consequences of assignment are important. A prudent investor shorting options on a continuous basis will tend to avoid or control assignment. Therefore i prefer short strangles.


----------



## screwjack

Shorting straddles on individual stocks is the quickest way to bankcruptcy. The key is to diversify or hedge enough to take the occasion surges/plunges. But if you do this you might as well short straddles on index. 
Numerious backtestings I've seen on S&P and Nikkei seem to show short straddle is a much more superior strategy than naked put (synthetically= covered call write) and naked call. Obviously the leverage you apply also affects the result hugely.


----------



## lefilter

humble_pie said:


> i bought a tad each of zwb & hex to compare with my own strategy which is different from these fund managers. I'm disappointed in the funds. An investor can do better on his own. Nothing more to add.


I agree. Bought some HEX when made available in march, and basically you get the same overall return (price + income) as the XIU, if not less, with a bit more fees. They seem to be very aggressive on the income generation (probably selling calls too close to the money) at the expense of capital appreciation.

I'll be progressively selling HEX and managing the call writing by myself.


----------



## OptsyEagle

humble_pie said:


> I'm disappointed in the funds. An investor can do better on his own. Nothing more to add.


I agree with this. You can't get too rigid with your covered call strategy. With ETFs they buy a specific set of stocks, at any price, and only sell specific calls, at any price.

An individual can sell a call ... or not sell a call. They can sell the underlying stock ... or not buy the underlying stock, they can put, straddle, waddle wiggle you name it.

The rigidity of strategy will seriously hurt those ETFs, in my opinion. It might be a good thing in stock portfolios but definitely not in covered call portfolios.


----------



## CanadianCapitalist

Horizons Portfolio Manager Eden Rahim participated in a live discussion on ROB today. Here is the link if you are interested in it:

http://www.theglobeandmail.com/glob...ility-using-covered-call-etfs/article2263101/

It is early days yet but it seems to me that the Canadian covered-call ETFs are basically providing returns more or less in line with the underlying. In other words, don't simply look at the high current distributions when looking at these ETFs.

PS: I merged this thread with an already existing humongous thread on covered call ETFs.


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## humble_pie

CC i only looked for 3-4 months but the covered write investor who religiously invested all distribs in new units thus increasing his no. of units quite substantially was coming out slightly ahead ...


----------



## avrex

CC, thanks for merging those threads.

I have also altered the title of the original first posting from
"ZWB - BMO Covered Call Canadian Banks ETF (and HEX)" to 
"Covered Call ETFs - ZWB, HEX, etc."
to more encompass the wider breadth of ETFs that are now available and to allow for futher discussion on these unique products.

Even though I've changed the title of the 1st post, it looks like the change is not reflected in the highest level title of the thread. oh, well.


----------



## CanadianCapitalist

humble_pie said:


> CC i only looked for 3-4 months but the covered write investor who religiously invested all distribs in new units thus increasing his no. of units quite substantially was coming out slightly ahead ...


When I looked at covered call ETF returns, I only looked at price change plus distributions. However, I think reinvesting distributions will likely show these ETFs having lower returns than the underlying just because they've been in a downtrend for most their existence. This is worth looking into to find out for sure.

PS: @avrex, I've changed the title of the thread per your suggestion. Thanks.


----------



## Lephturn

CanadianCapitalist said:


> When I looked at covered call ETF returns, I only looked at price change plus distributions. However, I think reinvesting distributions will likely show these ETFs having lower returns than the underlying just because they've been in a downtrend for most their existence. This is worth looking into to find out for sure.


That's not where I see the problem. In a down trend the covered calls will provide extra return that the underlying would not. The real problem comes when the underlying bounces back up stongly and the covered calls have to be rolled for a loss or the stock is called away and they get back in higher. That's the value trap - but in a down trend the covered call strategy should out perform plain long underlying.


----------



## HaroldCrump

But Lephturn, we _have_ been in a downturn since the spring.
Which roughly co-incides with the launch of these ETFs.
But they aren't out-performing the underlying.
So if they are not out-performing under their best case scenario, if/when we enter an upswing, they will perform even more poorly.

I also see that the call premiums are getting less and less.
These funds seem to be cutting their distributions on a regular basis.


----------



## Belguy

*BMO Covered Call Cdn. Banks ETF*

I would be interested in any thoughts which you might have on the BMO Covered Call Cdn. Banks ETF (ZWB). I understand that it has been quite popular since being recently introduced.

http://www.etfs.bmo.com/bmo-etfs/glance?fundId=83031


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## humble_pie

belguy there are 88 messages full of thoughts over the last 9 months about this etf. What more could you possibly want.

as it happens, i don't think this etf is suitable for you at all. You're probably not going to understand it, so it'll become a huge anxiety albatross next time a crisis hits & you have to dive underneath the bed again.


----------



## zylon

*Covered call ETFs: Good for income, not return*

or - how to convert Capital Gains into current income


> Are there times when it makes sense to own covered call ETFs? Yes, if you expected, with some certainty, that markets would rise slowly but steadily over the next year or so. But then, if you had that kind of certain information, there are better ways to make even more money.
> 
> http://business.financialpost.com/2012/02/10/covered-call-etfs-good-for-income-not-return/


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## avrex

*Covered call ETFs: Good for income, not return*

Full post here
Covered call ETFs: Good for income, not return (by Vikash Jain)

Since its start last March, HEX has earned dividends and call premiums totalling 11.9%. 
But its price fell about 21%, leaving a net total return of negative 9.2%. 
I constructed a portfolio of the same 30 stocks on Bloomberg, but without the call writing. 
It had a total return of about negative 4.9%, or 4.2 percentage points better than the covered call version.

Edit:  Just saw Zylon's post after posting mine. We are obviously reading the same article at the same time.


----------



## zylon

You "follow" Jon Chevreau too, I take it?


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## avrex

absolutely. Yes, I like many of the FP Investing writers.


----------



## OptsyEagle

I think covered call etfs are just a regret waiting to happen. Just my opinion.


----------



## fatcat

OptsyEagle said:


> I think covered call etfs are just a regret waiting to happen. Just my opinion.


i got burned by HEX exactly as described in the article and then got out ... lesson learned ... as the article points out well, you need to be able to predict the future curve of the market in order to do well in these products and if you can do that, you may as well write your own options and make a lot more


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## Sherlock

HEX is currently down to around $8/share but isn't it possible that it will go back up to $10 or more by the end of the year? Isn't it unfair to judge it based on such a short time frame? Look at PIC.A its return for the past 3 years is 47%.


----------



## Mall Guy

OptsyEagle said:


> I think covered call etfs are just a regret waiting to happen. Just my opinion.


The regret has already happened, declining unit price, declining distribution . . .


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## gibor365

HEX underperformed XIU in 1 year by 0.86% (dividends not reinvested).
ZWB underperformed ZEB in 1 year by 0.72% (dividends not reinvested).


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## OptsyEagle

I have reservations about writing covered calls at all, but will agree that for an experienced options trader who is actively managing the portfolio, they may do better and probably at least as well as a non-optioned portfolio.

When trading options, one definitely needs to be able to react to the new market that happens at the beginning of every new day. If the market goes against the active trader who has sold a call, they can buy it back and roll out another call to cover the loss, they can sell a put, sell the stock and then short it or move on to another stock altogether, etc., etc. ... passive ETFs cannot do this.

That is pretty much why I believe covered call ETFs are a regret waiting to happen.


----------



## andrewf

Sherlock said:


> HEX is currently down to around $8/share but isn't it possible that it will go back up to $10 or more by the end of the year? Isn't it unfair to judge it based on such a short time frame? Look at PIC.A its return for the past 3 years is 47%.


5 year return on PIC-A has been 6% (total, not annualized). Same figure for XIU was 5.5%. I suspect cherry-picking with your 3 year time frame.


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## Sherlock

andrewf said:


> 5 year return on PIC-A has been 6% (total, not annualized). Same figure for XIU was 5.5%. I suspect cherry-picking with your 3 year time frame.


I was simply trying to make my argument more compelling, is that illegal?


----------



## Causalien

Just checked back on this ETF. I am glad I have absolute belief in my own abilities.


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## humble_pie

as i once mentioned when ZWB & HEX were issued, i bought modest positions so as to compare with my own returns, since i practice a distinctly different approach. At the time i said i did not like their close-to-the-money option protocol. Their primary approach was & remains to own stock + sell short-term calls at or one strike above the money.

after a fair trial of one year i'm unimpressed. Where i think the managers are running headlong into trouble is with the in-the-money assignments. Immediately afterwards their mandate forces them to rebuy the same bank or tsx top 30 stock but at higher prices, thus shrinking the number of shares owned & lowering any collective dividend to be collected. Rinse & repeat.

in a rising market such as we've enjoyed, this procedure leads to grief. In a stable or falling market it would work out fine.

not that anybody would be interested, but for my part i sell calls that are farther out in time, usually about 6 months, plus the strike prices are positioned higher. I also sell otm puts, so the combined premiums are fat enough. Thereafter, the stock is free to move within the band created by this strangle. The only excitement occurs when the stock moves significantly above or below the band.

i've posted quite a few messages with formulas & tips about avoiding assignment, so i won't bore with the same now. The approach works fine. The only difficulty is with insanely soaring or desperately plummeting markets, & these only occur once or twice a decade.

to be honest i actually like them. Insanely or desperately, that is. There's nothing as boring as a bank or a big energy yielding 10% in tax-favoured income which one is sentenced to hold for the rest of one's life on earth ...


----------



## avrex

humble_pie said:


> not that anybody would be interested, but for my part i sell calls that are farther out in time, usually about 6 months, plus the strike prices are positioned higher. I also sell otm puts, so the combined premiums are fat enough. Thereafter, the stock is free to move within the band created by this strangle. The only excitement occurs when the stock moves significantly above or below the band.


We are interested. 
Thanks for sharing your strategies and analysis.


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## gibor365

humble_pie said:


> as i once mentioned when ZWB & HEX were issued, i bought modest positions so as to compare with my own returns, since i practice a distinctly different approach. ......to be honest i actually like them. Insanely or desperately, that is. There's nothing as boring as a bank or a big energy yielding 10% in tax-favoured income which one is sentenced to hold for the rest of one's life on earth ...


So HP, can we say that last couple of months HEX, ZWB .... paying less distributions because of the bulish trends in the markets?

I did some calculations comparing HEX vs XIU (from day of HEX inception) and found HEX underperfomed XIU by 0.9% (w/o DRIPing).
So, I'm in doubt, if i need to sell HEX and buy XIU (i hold both) or leave as it is


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## stephenheath

humble_pie said:


> Immediately afterwards their mandate forces them to rebuy the same bank or tsx top 30 stock but at higher prices, thus shrinking the number of shares owned & lowering any collective dividend to be collected. Rinse & repeat.


I asked them about this, they say in that case they just rebuy the option rather than rebuying the stock, so it just lowers their returns.



> to be honest i actually like them. Insanely or desperately, that is. There's nothing as boring as a bank or a big energy yielding 10% in tax-favoured income which one is sentenced to hold for the rest of one's life on earth ...


I really need to piece together your messages and understand this, I've got lots of bank stock just sitting there making 4-5%. That shall be my project for the weekend


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## humble_pie

stephen the first thing is to remember that a lot of front line call centre representatives - although i think all are doing flat-out the most terrific job they can - really don't know that much. So i don't think the guys answering the customer service phone at horizons have any real hands-on experience understanding what the fund managers are doing. I do think they try to do a helluva responsible job.

as for continually buying back short-term at-the-money call options because markets are rising briskly, this strategy is going to cost big bucks. Because the option premiums are rising faster than the stock. Plus the dealers will slaughter with the ask prices. Sometimes it's cheaper to let the stock get exercised away.

doc & cause will tell you - if they show up here - how all this is orchestrated by the gammas & the thetas driving the deltas, but me i just know it in my bones.


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## stephenheath

humble_pie said:


> stephen the first thing is to remember that a lot of front line call centre representatives - although i think all are doing flat-out the most terrific job they can - really don't know that much. So i don't think the guys answering the customer service phone at horizons have any real hands-on experience understanding what the fund managers are doing. I do think they try to do a helluva responsible job.
> 
> as for continually buying back short-term at-the-money call options because markets are rising briskly, this strategy is going to cost big bucks. Because the option premiums are rising faster than the stock. Plus the dealers will slaughter with the ask prices. Sometimes it's cheaper to let the stock get exercised away.
> 
> doc & cause will tell you - if they show up here - how all this is orchestrated by the gammas & the thetas driving the deltas, but me i just know it in my bones.


I hear you on the phone monkeys, they actually (a) couldn't answer so (b) got back to me with an answer even I knew couldn't possibly be right and when I gave them a follow-up question gave up and had the HEX fund manager email me, who then explained in as layman terms as he possibly could but still made me feel like a phone monkey 

And I think the biggest problem is that they're stating right out exactly what they're doing in every case... which as you say, let's the dealers know exactly what to target, I think everyone moving in on the same #'s has GOT to be at least part of the reason for declining performance, but I can't prove it, just a gut feel.

That said, while I'm losing my love for HEX and HEF, I'm enjoying HEE and theoretically HEP (been watching but haven't really jumped into HEP yet) because those stocks don't normally pay significant dividends and I don't really like holding stocks that rely on you finding a greater fool down the road.


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## JDWood

I emailed them yesterday asking why the div was dropping month over month. Replied same day with this:

Thank you for your email.

The yields have been dropping due to the drop in volatility in the general markets. The VIX is at its lowest level in 4 years. Covered Call strategies are able to harvest much more yield in volatile markets.

The Portfolio Management team has a very dynamic approach and in volatile markets they can write calls multiple times on each individual position over the course of a month. This enables them to generate higher monthly distributions.

Before these strategies came out, the expected yield for HEX, HEF, HEP, and HEP was roughly 10 -12%. This is the low end when back testing was done to account for low volatility in the market. If volatility picks back up in the market then you should expect the yields to go up accordingly


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## gibor365

what is the email address of HEX and HEE manager?


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## andrewf

VIX is not at its lowest level in four years. This is a baloney excuse.


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## gibor365

Maybe they wanted to say, VIX is the lowest since ETF inception?!

I checked last year performance of ZWB, HEX, HEE and compare with similar passive ETFs. HEE is the only one who really outperformed XEG.


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## doctrine

I can't believe HEX can't sustain 18% year over year. Imagine that.

I see the latest distribution has the yield down to 10%, and that's only if you buy it today. If you bought it a year ago, your yield is down to 8%. And you lost 20% of your capital.


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## gibor365

doctrine said:


> I can't believe HEX can't sustain 18% year over year. Imagine that.
> 
> I see the latest distribution has the yield down to 10%, and that's only if you buy it today. If you bought it a year ago, your yield is down to 8%. And you lost 20% of your capital.


But if you bought XEG you are down almost the same and dividends much less


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## gibor365

FYI,
Reply from BMO ETFs regarding ZWB:
_Thanks for emailing the BMO ETF team. I understand your inquiry is about ZWB’s decreasing distribution.



In 2011, ZWB had a portfolio yield of roughly 9-10%, which represents the return that the portfolio managers are earning off of the securities. The distribution amounts are set approximately 9-10% in an annualized figure based on the NAV or market price. Given the drop in the prices for the banks throughout the year, inn order to maintain that same distribution percentage, the distribution would have to be decreased accordingly.

For example, it is similar to the logic of 10% of $15.00 NAV would lead to a $1.50 annualized distribution whereas a 10% of $13.00 NAV would lead to a $1.30 annualized distribution.

However, it looks like in 2012, the portfolio yield has declined to 7-8% range and the portfolio managers have lowered the target for distributions as well. Until we have further guidance in the form of the annual report to be released in Q1 2012, we are not able to make any formal statements about it. _

From Horizons:
_The reason that the yields have been falling on the covered call ETFs is because the volatility in the market has also fallen. A covered call strategy is designed to harvest option premium from volatility to create an income strategy. When volatility is lower, like we have seen in 2012, there is less premium to be collected.
You should however notice that when volatility is low, it means that the trend in the market is upwards. This is why you have seen the NAV of the fund grow with the underlying basket of stocks._


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## andrewf

I don't buy it.


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## webber22

Has anyone received their tax info (T5) for the HEX or ZWB ? I'd be curious to see how much is capital gain versus other income


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## gibor365

webber22 said:


> Has anyone received their tax info (T5) for the HEX or ZWB ? I'd be curious to see how much is capital gain versus other income


I hold it in RRSP, so I don't care


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## Mall Guy

gibor said:


> I hold it in RRSP, so I don't care


Me too, but I am still underwater in my RRSP and RESP !


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## gibor365

Mall Guy said:


> Me too, but I am still underwater in my RRSP and RESP !


Me too  I'm down big time on HEX, a little bit on ZWB, in gain on HEX (bought it much later in 2011)....


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## Belguy

Beware covered call ETF's:

http://www.archeretf.com/covered-ca...gn=8f849c3dc5-IQ_DIA_27Feb12&utm_medium=email


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## webber22

ZWB 2011 Taxation info listed below. It contains the dreaded return-of-capital and quite a bit of it ....

Eligible Dividends 0.358598
Capital Gains 0.328336
Return of Capital 0.615066
Total Distribution 1.302000

http://www.etfs.bmo.com/bmo-etfs/distribution?fundId=83031


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## stephenheath

Taking your numbers, Webber, and adding HEX beside it from their 2011 distributions guide on the website it's a surprising difference:

ZWB // ZWB as % // HEX %

Eligible Dividends 0.358598 // 27.5421% // 3.88%
Capital Gains 0.328336 // 25.2178% // 92.75%
Return of Capital 0.615066 // 47.2401% // 3.37%
Total Distribution 1.302000

I also hold horizons' HEP... that was is 0% ED, 99.18% CG's, and .82% RoC.

Source: http://www.horizonsetfs.com/excel/Distribution_Summary.xls

On a side note, why is return of capital dreaded? Isn't it basically deferred capital gains?


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## webber22

That's great Stephen, so HEX is a pure capital gain play. I imagine most people are holding HEX and other covered call etf's in registered plans like Gibor. Can't imagine seeing the fund drop 10% during the year and then having to claim a big chunk of capital gains. 

As far as the return of capital ROC for ZWB, I don't like keeping track of it each year for tax purposes, I was waiting for these details before buying it. As long as the ROC is coming from unrealized capital gains, shareholders should not be concerned


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## bettyboop

I'm thinking of selling ZWB for a loss and buying HEX instead. The share price and the distribution have dropped on both so there shouldn't be much more risk with HEX and the divy is higher.


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## andrewf

Mrs. Boop: they are both a waste of time. Pay no attention to the yield. All that matters is total after-tax return. You're probably better off with a vanilla equity ETF--it'll have lower fees.


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## humble_pie

i've lost track of the number of early messages i posted in this forum about the ways in which the 2011 covered call fund managers could inflate the distributions in the early months in order to attract a large book of business.

in particular, i was doubtful about their short-term close-to-the-money strategy. Although this strategy is embraced by the majority of so-called option "teachers," it is not one i believe in. In sharply rising or falling markets it's a disastrous strategy.

in fact, the ideal market for a HEX or ZWB strategy is one in which the underlying stocks never move at all, but instead their prices tread water in place, year after year. Of course in such a scenario their premiums will decline severely. Hello, Alice in Wonderland.

better strategies are option strikes set 2 or more levels above market, plus some puts set several levels below. This opens a much wider trading band in which a stock can move without triggering exercise.

it is true that such a strategy will pay less cash distribution, but it will largely protect big capital gains within a portfolio, so the investor gets to benefit 3 times from the capital gains, dividends & option income combo.

on the downside, it will open more risk. But parties who don't understand these risks are not supposed to play in these funds in the first place.


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## lefilter

HEX was a let down. I bough some early 2011, being cautious about the canadian market. Knowing (thanks HP) they were selling very close to the money, i tought I could sacrifice a bit of upside in exchage for more income and more downside protection.

At the end of 2011, TSX was down 9% and the HEX total return was down about the same. 2011 should have been the perfect year to showcase that ETF ability, giving some downside protection. This downside pressure is so strong, im even wondering whats going to happen to the unit price and total NAV value in 5 to 10 years. We could look at upside beta vs downside confirm this "downside bias".


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## dcaron

Just was wondering whether the timing is good to add HEX to my SDRSP portfolio currently, now that it is at its 52 week-low, and dividend has produced good returns since inception a year ago (~11%)...


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## gibor365

dcaron said:


> Im not a sophisticated investor. Just was wondering whether the timing is good to add HEX to my SDRSP portfolio currently, now that it is at its 52 week-low, and dividend has held steady for a year (~11%)...


I don't see where you find steady dividends for HEX or ZWB. Dividends were going sharply down several months in a row. After last disptribution cut about month ago , I sold both ZWB and HEX. Still hold HEE. 
_I'm thinking of selling ZWB for a loss and buying HEX instead._ If you want exposure to banking sector, better to buy ZEB. I already have big exposure to individual Can banks, so from part of ZWB sell both NA (that I didn't have before).


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## andrewf

The 11% dividend is an illusion. These covered call ETFs are a 'clever' way of converting capital into capital gains. There performance (on a total return pre-tax basis) is likely to be very similar or worse than a equity ETF tracking the same underlying stocks. Once you add in the tax implications of the capital gains distributions, these funds because highly questionable.

Moral of the story: yield is *irrelevant*. You need to consider total return. Buying a covered call ETF because it distributes 11% annually is akin to buying a bond with a 20% coupon but a 10% yield to maturity. It trades at a large premium, and you turn capital into interest income.


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## dcaron

andrewf said:


> The 11% dividend is an illusion. These covered call ETFs are a 'clever' way of converting capital into capital gains. There performance (on a total return pre-tax basis) is likely to be very similar or worse than a equity ETF tracking the same underlying stocks. Once you add in the tax implications of the capital gains distributions, these funds because highly questionable.


Pardon the newbie question, but why would tax implications matter if this is owned in a registered account?



andrewf said:


> Moral of the story: yield is *irrelevant*. You need to consider total return. Buying a covered call ETF because it distributes 11% annually is akin to buying a bond with a 20% coupon but a 10% yield to maturity. It trades at a large premium, and you turn capital into interest income.


Why does this matter when buying at the yearly low? Is there much more room for the ETF to go down?


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## andrewf

Why do you care about distribution rate for assets held in a registered account? What's the advantage of a fund that distributes 11% annually with no total return gain?


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## doctrine

The reason it is a problem is because the total return of the covered call ETFs is less than just holding the stocks. They're losing money. Both HEX and ZWB. Options is a zero sum game except for the fees, so essentially these ETFs are money generating machines for the options traders who handle them.


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## CoveredCallETFs

doctrine said:


> The reason it is a problem is because the total return of the covered call ETFs is less than just holding the stocks. They're losing money. Both HEX and ZWB. Options is a zero sum game except for the fees, so essentially these ETFs are money generating machines for the options traders who handle them.


To be fair, I think that the current context of a fast rising market is about as bad as it gets for covered call ETF's in terms of comparing their returns with long only ETF's... not saying they're a great job, but they would perform best in a flat market


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## dotnet_nerd

I'm happy with ZWB so far. I only have a small position, 500 shares I bought at $14.11 in Jan.

Even with the dividend drop I still get $42.50/month (7.2% annualized)

I'll keep it on a tight leash but so far so good.


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## rassmy

Forget about HEX, I would pick ZWB. It has 50% invested in ZEB and the other 50% covered calls. Very good pick for income/dividedn investors who are looking for monthly income distribution.


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## CanadianCapitalist

FWIW, Horizons points out the HEX has outperformed the underlying long-only portfolio by "roughly 2% before trading expenses" from inception to Jan. 31, 2012. They claim (fairly, IMO) that comparing HEX to XIU is not appropriate. That may be the case but an investor does not have an easy way of replicating HEX's stock holdings. And over the long term (at least 5 years), it will be entirely appropriate to compare HEX with XIU.


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## HaroldCrump

rassmy said:


> Forget about HEX, I would pick ZWB. It has 50% invested in ZEB and the other 50% covered calls. Very good pick for income/dividedn investors who are looking for monthly income distribution.


After this week's blowout earnings by the banks, I decided to run the performance numbers for covered call ETF (ZWB) vs. long stock only bank ETF (ZEB).
The underperformance of ZWB vis-à-vis ZEB is shocking, and it seems to be getting worse with time.

I totaled up all the distributions for each of the ETFs and ran an IRR calculation, assuming all distributions are held as cash (i.e. not re-invested).
See results below.










Here are a few (shocking) key observations:
- Covered call ETF (ZWB) has experienced 0 capital appreciation in over 2.5 years, despite the fact that all bank stocks are significantly higher now than in spring of 2011 when ZWB first launched.
- This is even more surprising since nearly 50% of ZWB's holdings are actually ZEB itself
- It would appear that _the entire_ capital appreciation has been paid out as distributions, and then some.
- The fund manager's strategy of selling near term covered calls close to the money, and then having to buy those calls back is creating a significant drag on total return.
- ZEB's distributions are increasing over time, whereas ZWB's distributions are falling

To be fair, the last 2.5 years since ZWB has existed is the exactly wrong kind of market environment for the strategy they seem to be following.
Bank stocks have risen consistently through the last 3 years.
We are yet to experience a flat or gradually falling market environment where this type of ETF can (potentially) outperform ZEB.

Following are all the short call positions they are currently holding.
As we can see, almost all the positions are either ITM or quite likely to be before expiration (with the possible exception of BNS calls).
They will have to pay more to close these out.










In general, other than satisfying a pure monthly income generation requirement (at the cost of long term capital gains), this type of ETF serves no useful purpose in a portfolio.

I haven't done a similar analysis for other covered call ETFs like HEX, and the results could possibly be very similar.
Although, energy stocks in general have better option premiums than bank stocks so it _may_ fare marginally better.
Not enough reason to consider, IMO.


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## Mall Guy

My ZWB finally came back above water, dumped it and ran . . . ever decreasing distribution, dead money as Harold says above. Good riddance !!!


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## avrex

Good analysis, @HaroldCrump.
Thanks for doing that.


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## humble_pie

the strategy practiced by these funds is only one of several covered call strategies. It happens to be the worst.

_(music: big band swing)_
the problem was, these guys were always selling too close to the money.
only one increment above.
oops they got assigned.
that is, their stock was called away from them at the short call strike price.
even though market price of the stock may have been a dollar or 2 higher at the time.

_(music: dixieland)_
unfortunately their fund mandate forced them to use the proceeds of the assignment to buy back the same stocks.
price per share was now higher than assignment, so, sadly, they acquired fewer shares.

_(music: harlem blues)_
they never learned anything from the experience so they continued selling too close to the money.
meanwhile fewer shares paid fewer dividends.
oops, another assignment

_(greek chorus) (wail 23 times)_
sell calls
get assigned
buy fewer shares
repeat every 30 days


----------



## bettyboop

Mall Guy said:


> My ZWB finally came back above water, dumped it and ran . . . ever decreasing distribution, dead money as Harold says above. Good riddance !!!


Congratulations Mall Guy! We must have bought about the same time, I noticed mine was also FINALLY up, by a whole $35.00 I didn't get a chance to sell though but I will on Tuesday. I will be sooo happy to finally get rid of this.


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## bettyboop

just checked again, up 25.86 not 35


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## james4beach

HaroldCrump: good stuff, thanks.

Just another illustration of a fund where capital appreciation is traded off for distributions & yield. In this case it looks like a total tradeoff... as Harold indicates, no capital appreciation despite amazing performance of the underlying stocks! All those gains have been totally converted to income.

That's not terrible in itself, except it looks like the total return is going to be worse than just holding ZEB. Not too surprising... theory would suggest that the more complicated intermediary steps happen, the more inefficiencies there are and the worse the performance drag.

Financial middlemen have the uncanny ability to hurt performance (i.e. take your money)

Since you've already got a discount brokerage, why not just "do it yourself"? Cut out the middleman who uses complicated tricks to generate income. Just have your core position in the plain vanilla ETF (whether XIU or ZEB etc). Receive the excellent dividends, and periodically sell shares to generate more cash. Maybe sell shares twice a year. Buffer the proceeds of sales into HISA.

And "pay yourself" out whatever level of income you want. *Make it as high a 'yield' as you want!* That part is totally arbitrary. You'll end up better off this way, with fewer complex investments, fewer middlemen, lower fees, and more control of the process.


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## humble_pie

people dumping now never understood how these funds work, should never have played in these funds in the first place.

in flat markets, covered call funds like these can work.

in rising markets such as the one we've had in canadian banks, they will fail.

in falling markets, such as the one we passed through in canadian energy not long ago, they will fail.

did any of the recent dumpers read the prospectus?
did any of the dumpers have the least understanding what they were buying?
did any of the dumpers consider the numerous warnings posted all through this thread, right from the very beginning?
were any of the dumpers motivated to buy by anything other than blind greed?


----------



## HaroldCrump

I ran the numbers for the other major covered call ETF being discussed here - HEX.
The long stock only ETF closest to HEX is the big ol' grand-daddy of Canadian ETFs - the XIU.

XIU has a long history so I ran the performance comparison from the date of HEX inception only (3/18/2011).
Assumption is again all distributions held as cash i.e. not re-invested.










As we can see, HEX fared very bad compared to XIU.
Underperformance is even worse than ZWB.

Distributions are indeed quite high, therefore, the investment thesis for these covered calls ETFs is essentially : _I want a monthly income, everything else be damned._
These ETFs are like those reverse mortgages retirees sometimes take on...you get a monthly income in exchange for slowly withering away your equity.

Given that the TSX is down about 7% since spring of 2011 when HEX launched, these covered calls ETFs don't seem to work even in slightly falling market conditions.
Unlike what they claim on their website:


> To mitigate downside risk and generate income, HEX will generally write covered call options on 100% of its portfolio securities.
> Covered call options provide a partial hedge against declines in the price of the securities on which they are written to the extent of the premiums received.


So when humble_pie says above that these products can work only in flat markets, it would appear that the markets need to be truly flat - i.e. nearly dead - for these products to work.
Slight up or down, and not only will they not work, they will cause significant damage.


----------



## humble_pie

HaroldCrump said:


> ... So when humble_pie says above that these products can work only in flat markets, it would appear that the markets need to be truly flat - i.e. nearly dead - for these products to work.
> Slight up or down, and not only will they not work, they will cause significant damage.



yes, i think so.

HEX is what i was alluding to when i mentioned the dip in energy prices affecting any covered call fund using the short-term strategy that HEX employed plus the 30 stocks (energy-heavy) that HEX chose.

in addition HEX would probably have been hurt by RIMM (remember, horizons beta only used interlisted stocks with US options in this fund.)

a good no-hysterics covered call strategy imho is to sell options something like 2 increments above market. Since time decay has already eroded most of the value out of these calls in the short-term, it's necessary to go out 6 or 9 months.

it's also necessary to select quality stocks with wide trading bands - ie enough volatility to pack premium into the options - plus these stocks & their options need to be very liquid. In canada, this drastically narrows the field.

one might as well sell puts, too, at the opposite or lower edge of the trading band. The covered call then becomes a strangle. After all, at the end of the day only one of the 2 positions is going to be even remotely near the money. The other position will be home free dollars.

one ends up with a portfolio studded with puts & calls, with only a few maturing each month. Sort of like a GIC ladder except a lot more fun.


----------



## james4beach

humble_pie said:


> did any of the recent dumpers read the prospectus?
> did any of the dumpers have the least understanding what they were buying?


You're kidding right?  Nobody reads the prospectuses. Nobody EVER reads the financial statements... I wish they would...


----------



## avrex

When we started this thread, back in 2011...


avrex said:


> We'll follow their progress and question the risks and taxation implications.


We are now drawing some conclusions on these products. Great analysis by everyone above.


----------



## humble_pie

HaroldCrump said:


> it would appear that the markets need to be truly flat - i.e. nearly dead - for these products to work



yes the ideal is a dead etf - an Embalmed Trash Fund.

i for one don't understand exactly how a CC approach can work so badly for the funds. I'd need access to their books to see exactly what they're doing.

CCs work for millions of people, though. I think it's important to stay out of harm's way ... launch the first call at least 2 increments above market, depending on how bullish or how bearish one is.


----------



## kitbuilder

HaroldCrump said:


> ...So when humble_pie says above that these products can work only in flat markets, it would appear that the markets need to be truly flat - i.e. nearly dead - for these products to work.
> Slight up or down, and not only will they not work, they will cause significant damage.


Thanks HaroldCrump for the excellent analysis and commentary. This point you made about the market having to be absolutely flat really sums it up. I bought a bit of ZWB in May 2011 and sold all of it in May 2012. Comparing to ZEB back then, it was apparent that the downside for ZWB was just the same as ZEB, but that the upside was limited. Same risk, but less reward. After seeing the growing divergence between the two price charts, it was an easy decision to exit ZWB. HEE and HEX too.

These products really remind me of commodity ETFs with the contango effect or leveraged/inverse/volatility ETFs intended only for day-trading.


----------



## fatcat

i learned my lesson with HEX ... took a small loss and never looked back

they seemed tailor made to snare yield hungry investors who are easily dazzled by the numbers


----------



## Mall Guy

humble_pie said:


> 1. people dumping now never understood how these funds work, should never have played in these funds in the first place.
> 2. did any of the recent dumpers read the prospectus?
> 3. did any of the dumpers have the least understanding what they were buying?
> 4. did any of the dumpers consider the numerous warnings posted all through this thread, right from the very beginning?
> 5. were any of the dumpers motivated to buy by anything other than blind greed?


Because you ran my bell, so to speak, I went back and looked at how it performed for me over the last 2 or so years . . . going to school is expensive, so one likes to learn the lesson the first time round. I seldom buy products that are based on financially engineering (well that may not be completely true as some might argue REITs are just that). This was a departure, for about 3.5% of my portfolio. Although I understand the concept, I lack the technical skill to pull off covered calls. With that in mind:

1. Agreed;
2. nope, just the marketing overview, would not have seen through the problem with the product if I had;
3. of the concept yes, but see #1
4. too late, may have owned it before becoming a member;
5. blind greed ? if by that you mean trying a different angle on Canadian banks, maybe. Trying for a little extra yield, certainly.

It was "okay" in the early days, until the underlining ZEB started to pull back as the bank stocks pulled back (added some bank stocks during that period). Then they start to move up, and ZWB could not generate any extra yield from CCs. Yield dropped around 40% and is currently not much above the underlying dividends of the banks held in ZEB. 

Having said all that, with the distribution, and the sale at +/- my NBV, it wasn't really terrible, but a slippery slope none the less ! Then again, I own BMO directly!


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## GalacticPineapple

humble_pie said:


> CCs work for millions of people, though. I think it's important to stay out of harm's way ... launch the first call at least 2 increments above market, depending on how bullish or how bearish one is.


If one wants to apply one's own CC strat to an index of U.S. stocks, an ETF like SPY works. But is there a similar ETF for international stocks? I'm only finding ETFs with thinly traded options.


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## avrex

The case against covered call ETFs


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## humble_pie

not long after covered call ETFs made their much-publicized debut, some financial commentator said that no one except an experienced option trader - one who would understand how they were constructed & how they would function - should ever buy them.

tis true. I did understand & i did oppose them.

HEX was an example of bookish Theory being applied to options trading without enough practical experience to understand all of the scenarios that could potentially unfold.

what happened was the worst kind of scenario for HEX. Their prospectus limited them to 30 top liquid TSX stocks that also had US options. The big mistake was selling very short term call options - 30 to 60 days - only one increment above the money.

in a sharply rising market, this will mean that the call option will be assigned while the share price has likely soared higher than the option exercise price. Example: stock is at 30, manager sells a 60-day $32 call. However stk then soars to $35 & he loses all of the holding at 32. The premium he received when he sold the call (when stk was at 30) is not enough to bridge the gap up in share price.

the problem is that, immediately after assignment, the manager's mandate forces him back into the market to rebuy the exact same just-called stock that he had to let go at 32, but now he must pay 35. This means fewer calls to sell & fewer dividends. Rinse & repeat. It's a fast slide downwards.

i don't do this btw. In addition, i don't believe that any investor should ever give away options management to any other party whomsoever. I believe an investor should either learn to manage for himself or else stay away from options.

PS re HEX, the final nail in the coffin was the collapse of RIM, one of the 30 underlyings.

the BMO bank CC ETF has some built-in relief since half the fund holds the regular non-optioned bank ETF.


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## james4beach

It's been more than a year... let's revisit HEX. This is of course yet another income fetish ETF. The criticism noted earlier was that total return is what matters, and it's unlikely that HEX would exceed the TSX Composite total return. That's because boosting "income" trades off for capital appreciation. _It always does_.

Here's the total return performance so far up to 2016-02-29

HEX
2012: 4.12%
2013: 5.07%
2014: 3.68%
2015: -7.29%
1 year: -10.88%
*3 year: 0.05%*

XIC (plain old index)
2012: 6.89%
2013: 12.71%
2014: 10.41%
2015: -8.35%
1 year: -12.93%
*3 year: 3.06%*

While HEX beat XIC in the last year, the longer term picture seems pretty clear ... all that dividend and income chasing is a losing strategy. HEX is doing _3% annualized worse than XIC._ That's one of the worst underperformances I've seen yet among income fetish ETFs.

ZWB (covered call)
2 year: 1.02%
3 year: 4.77%
*5 year: 5.16%*

ZEB (equal weight banks)
2 year: 0.94%
3 year: 5.71%
*5 year: 5.90%*

ZWB is at least doing better... outperforming in the short term, and for the longest range available only doing slightly worse.

Hopefully after several years of this "income ETF" craze, people now see that long term performance _matches the index_ at best, but probably is worse. This has been my assertion for several years.

So the boring answer, as before, is: *seek the best total return*. If you want a high income stream, invest in the benchmark ETF (like ZCN or XIC) and sell shares as needed to generate cash. You'll do better than a specialized or exotic income ETF. We have some discussion of the concept here, and you should also read these fantastic articles:

A better way to generate retirement income
The income illusion


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## jerryhung

only saw this thread now, oops

Count me as chasing yield/income with HEX (thinking it was diversified!) and loss since 2015 at $7, thankfully I averaged down some below $6 and is only down 5%?

Looking to ZEB/ZWB/XFN now again after selling my bank stocks


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## humble_pie

in static or slightly falling markets, a fund such as HEX could conceivably do somewhat better than a fund merely holding the same 30 underlying stocks.

somewhere nearby i posted an attempt to explain why a fund with a narrowly-defined universe like HEX - dividend 15 used to be another one - ends up cannibalizing itself in steadily rising markets. 

an individual option trader has far more freedom to roam to other stocks. What dividend 15 did recently was formally change its mission so it could write options on stocks other than the original small group of 15 canadian large caps for which it was named.


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## avrex

james4beach said:


> *seek the best total return*. If you want a high income stream, invest in the benchmark ETF (like ZCN or XIC) and sell shares as needed to generate cash. You'll do better than a specialized or exotic income ETF.


+1

For most people, this is the optimal solution.



humble_pie said:


> an individual option trader has far more freedom to roam to other stocks. What dividend 15 did recently was formally change its mission so it could write options on stocks other than the original small group of 15 canadian large caps for which it was named.


Agreed. Some individuals have the time/inclination to research and be nimble in selecting individual option positions.


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