S&P/ASX 200 Covered Call ETF

Covered calls are an investment strategy where investors buy a stock, or group of stocks, and sell call options on them. Selling call options can generate additional income for a fund, as buyers pay “premiums” for the right to buy assets at a fixed (“strike”) price. The logic behind selling call options against assets investors already own is that it ensures investors are “covered” from a margin call perspective – hence the term “covered call”.

The primary benefit of covered calls is that they can generate more income, and on a more diversified basis, than just owning dividend-paying stocks. This is because covered call sellers receive two income streams: first the dividends, second the premiums from the calls they sell. The premiums not only provide an income uplift, but also a second stream to draw from if dividends fall or dry up. Furthermore, options premiums tend to be inversely correlated to dividend yields—with lower dividend yielding stocks producing higher premiums – creating a natural hedge.

Covered call income is also hedged against volatility and interest rates. All else being equal, when volatility rises, option premiums rise as options traders price higher probabilities of sharp share price movements into calls. And when interest rates rise, call option premiums mechanically rise too, as call sellers provide, in effect, a loan to buyers. The economics of which gets priced into premiums.

By writing covered call options in return for the receipt of premiums, investors forego the opportunity to benefit from potential increases in the value of the S&P/ASX 200 Index above the exercise prices of such options but will continue to bear the risk of declines in the value of the S&P/ASX 200 Index.

The premiums received from the options may not be sufficient to offset any losses sustained from the volatility of the underlying stocks over time. As a result, the risks associated with writing covered call options may be similar to the risks associated with writing put options. In addition, AYLD’s ability to sell the securities underlying the options will be limited while the options are in effect unless AYLD cancels out the option positions through the purchase of offsetting identical options prior to the expiration of the written options.

Writing covered calls on the S&P/ASX 200 Index has all the familiar income advantages of buying S&P/ASX 200 shares. Investors receive all the dividends and franking credits that they do from owning the shares in the underlying index. However, writing call options provides a third source of income, derived from the premiums received from the selling of options. (Option sellers are not required to forego the dividends and franking credits they receive.) This means covered call strategies can generate income above what can be generated from just owning the shares. Furthermore, call option premiums provide a hedge against falling dividends, as call options premiums are usually larger for companies with little to no dividends.

The fund invests in the S&P/ASX 200 Index on a fully replicated basis. It then sells quarterly at-the-money exchange traded S&P/ASX 200 Index call options worth roughly 100% of the value of the portfolio, with the cash received from option sales reinvested into the S&P/ASX 200 Index. “At-the-money” options are those options with strike prices identical to the price of their underlying securities. Options are rolled the day before expiry. Expiring options are bought back at the time weighted average ask price between 4:20 pm and 4:25 pm Sydney time. New options are simultaneously sold at the time weighted average bid price.

To receive a distribution, you must own the ETF – the trade must have fully settled – on the record date. This means that you should aim to buy AYLD at least two business days before the record date (as ETF trades take two business days to settle) should you wish to receive a distribution.

The record date is the date on which Computershare, the share registry, records who owns which ETFs and therefore who is entitled to distributions. As AYLD has multiple distributions throughout the year, it has multiple record dates throughout the year too.

Distributions are paid on the payment date, which is announced ahead of time on the ASX’s website. Generally speaking, the payment date falls two weeks after the record date. On the payment date, investors will receive the cash – or new ETFs, if they choose to reinvest their distributions. Franking credits are distributed via the year-end AMMA statement, which is usually issued around the end of financial year (in July or early August). Details of payment dates and frequencies are available on the fund’s website.

We (Global X) will usually forecast how big we expect a distribution to be around one week prior to the ex-distribution date. This forecast is made public on the announcement date. While these forecasts will be as accurate as practically possible, they are only estimates and are subject to corrections and revisions.

The size of distributions is primarily determined by markets in the fund’s underlying assets. Variables include – but are not limited to – dividends and price movements in the fund's underlying shares, the size of option premiums, prevailing interest rates and market volatility.

Fund operations can also impact distribution sizes. Management fees, transactional and operating costs typically lower a distribution. Distributions can also be impacted by the number of units in the fund on issue on the ex-distribution date. Where the number of units on issue declines in the leadup to the ex-distribution date, the distribution yield should be expected to expand. (Income accumulated between distributions is therefore spread over fewer units). An opposite dilutive effect occurs when the number of units on issue increases in the leadup to ex-distribution dates.