For Canadian investors focused on generating passive income, two strategies have become especially popular in recent years: covered calls and modest leverage.
Covered calls work by selling away part of your upside potential in exchange for option premium income today. Leverage, meanwhile, allows a fund to modestly amplify exposure using borrowed money. When combined together, these strategies can produce very high monthly distribution yields.
Of course, there is no free lunch here. Higher yields usually come with tradeoffs, including capped upside during strong bull markets, higher volatility, greater complexity, and potentially weaker long-term total returns compared to a simple buy-and-hold index strategy.
Still, if your primary goal inside a Tax-Free Savings Account (TFSA) is generating recurring monthly cash flow rather than maximizing growth, these types of exchange-traded funds (ETFs) can potentially fill that role.
Two of the more popular examples in Canada today are the Hamilton Enhanced U.S. Covered Call ETF (TSX:HYLD) and the Hamilton Enhanced Multi-Sector Covered Call ETF (TSX:HDIV).
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Hamilton Enhanced U.S. Covered Call ETF
HYLD is essentially designed as a one-ticket U.S. income solution. Instead of holding individual U.S. dividend stocks directly, the ETF owns a diversified portfolio of underlying U.S. sector covered call ETFs managed by Hamilton.
That includes exposure to sectors like financials, technology, utilities, healthcare, energy, and industrials. On top of that, the underlying holdings themselves use covered call strategies to generate additional option premium income.
The ETF also uses modest leverage of approximately 25%, or 1.25 times exposure, to help enhance both yield and total return potential. Combined together, the structure is specifically engineered around maximizing distributable monthly cash flow.
For TFSA investors seeking high income tied to U.S. equities, HYLD effectively bundles diversification, covered calls, and leverage into a single ETF. As of May 15th, HYLD currently pays a 12.5% annualized yield.
Of course, investors should understand the tradeoffs. During very strong bull markets, covered calls can limit upside participation because portions of future gains are effectively sold away through the options strategy.
Hamilton Enhanced Multi-Sector Covered Call ETF
HDIV takes a somewhat different approach by focusing more heavily on Canadian income sectors. The ETF owns a diversified mix of Hamilton’s covered call ETFs spanning banks, utilities, pipelines, telecoms, healthcare, technology, and real estate.
Like HYLD, HDIV also employs approximately 25% leverage to enhance distributions. The covered call overlay helps generate recurring option income, while the leverage amplifies the overall exposure and distribution potential.
That combination has helped HDIV become popular among Canadian investors specifically looking for high monthly cash flow inside registered accounts like a TFSA. HDIV currently pays a 10% annualized yield.
Just remember that high yields come with above-average risk. The underlying ETF prices can still fluctuate materially over time, and distributions themselves are never guaranteed.
