By Canadian income investors have a lot of options when it comes to higher-yielding passive income products these days. With the growing popularity of covered call ETFs, investors can now score income that goes above and beyond just the dividends collected from an ETF’s holdings.
Of course, perhaps there is no more intriguing option in the income ETF space than the covered call ETFs, which tend to own dividend-paying stocks while adding a covered call strategy on top, effectively trading off upside potential for premium income.
Source: Getty Images
The case for covered calls
Indeed, the bonus yield from writing covered calls really can move the needle on monthly income. But, of course, there are trade-offs that not every investor is going to be comfortable with. Most notably, higher fees (management expense ratios) and a ceiling on upside are two “catches” that may act as dealbreakers for some.
Not to mention, it can be tough to gauge performance, given all the factors involved in how a covered call ETF fares. On the one hand, the performance of the underlying holdings counts, but at the same time, option premiums can be quite unpredictable.
For those who don’t mind a bit of surprise, though, I do think that covered call ETFs can be winners (relative to their non-covered call comparables) in a choppy, flat market that’s in a bit of a painful digestion phase (think a market that drags lower).
In such a climate, where there’s no upside to really cap and options premiums are still rich (due to higher implied volatility), covered call ETFs can really shine and be more than worth the higher fees they command.
BMO Covered Call ETF: A standout high-yielder
These days, the BMO Covered Call ETF (TSX: ZWU) stands out as a specialty income ETF to watch closely. And I’m going to be frank: the hefty 7.5% yield is a huge part of why I was drawn to this specific thematic covered call ETF. That said, I’m also a fan of the ETF’s lower correlation to the hottest parts of the AI trade (that some of our portfolios may be overexposed to, knowingly or not), which might just be in for a bit of a reckoning.
Either way, much of the utility scene, by its very nature, is all about the “slow and steady” mature cash producers that don’t tend to shock and awe. But in today’s rate-jittery climate, the utility stocks have been anything but steady, with shares of the BMO Equal Weight Utilities Index ETF (TSX: ZUT) (my preferred gauge for Canadian utility stocks) coming back after a painful summertime correction.
With utility stocks under pressure, yields swelling, and options premiums looking enticing (especially as interest rate uncertainty moves into 2027), I do think that the ZWU could be a great place for passive income investors to take on a more tactical position. The ZWU itself is coming back from a correction of its own. And while there’s still downside risk involved with covered call ETFs, I do find that the bountiful yield can act as a nice cushion.
So, in short, ZWU definitely looks to be worth a look after the latest dip. The yield is becoming too good to ignore, even if the environment doesn’t stay as conducive to as high a yield over time.