Canadian banks are a core holding for many domestic investors. They’re stable, profitable, and have long dividend histories. By extension, bank exchange-traded funds (ETFs) are popular, too.
For a small management fee, you get a diversified basket of the Big Six banks that someone else maintains and rebalances on your behalf. Plus, with ETFs, you typically get paid monthly instead of quarterly, something dividend investors love.
Some advanced bank ETFs go a step further, using strategies like leverage or options to boost yield or enhance returns. A great example of one that uses the latter is BMO Covered Call Canadian Banks ETF (TSX: ZWB). Here’s why this off-the-radar pick could be especially appealing in a Tax-Free Savings Account (TFSA).
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What is ZWB?
ZWB is designed to give you exposure to Canada’s Big Six banks while boosting your income through a covered call strategy. It charges a management expense ratio of 0.71%, which is higher than a basic bank ETF, but that’s the price for the extra income it generates.
At its core, ZWB equally weights shares of all six major Canadian banks. This means it doesn’t give more weight to bigger banks, so you get even exposure to each. The portfolio is refreshed twice a year—this is called being “rebalanced” and “reconstituted.”
Rebalancing adjusts the weights back to equal if market moves have shifted them. Reconstitution replaces any companies if, for some reason, one of the Big Six were to be dropped or if the index rules change.
What really sets ZWB apart is its use of covered call options. This strategy involves selling the right for someone else to buy the bank stocks in the portfolio at a set price in exchange for a cash payment called a premium.
ZWB doesn’t just randomly sell these options. It writes them “out of the money,” meaning at a price above current market levels, so the stocks have room to rise before the option would kick in. The options it writes are also chosen based on “implied volatility,” which is just a fancy way of saying ZWB aims to pick the ones that are most lucrative.
The trade-off here is that while you earn more income from the option premiums, you give up some of the upside if the bank stocks rally sharply.
How much does ZWB pay?
At a market price of $19.86 per unit, ZWB’s most recent monthly distribution of $0.11 may not seem dramatic at first glance. But when you annualize that amount (multiply it by 12) and compare it to the current price, you’re looking at a 6.65% distribution yield. That’s solid monthly income from a basket of Canadian bank stocks and a big reason why this ETF appeals to income-focused investors.
If you’re holding ZWB in a non-registered account, things get more complicated. In 2024, the total per-unit payout was $1.32, but only about $0.76 of that was an eligible dividend. The rest, around $0.56, was classified as return of capital, which isn’t taxed immediately but lowers your cost base, leading to larger capital gains tax later when you sell.
To keep things simple and fully enjoy the income tax-free, your best bet is to hold ZWB inside a TFSA. That way, you don’t need to worry about tracking the return of capital or calculating an adjusted cost base, as every dollar you receive stays in your pocket.
