Before You Buy a Covered-Call ETF, Check These 3 Numbers

A covered-call ETF’s big “yield” can hide return-of-capital and capped upside, so check the numbers that show what you’re really getting.

Key Points
  • Covered-call distributions can include dividends, option premiums, gains, and sometimes your own capital, so compare forward and trailing yields.
  • Look up the option coverage percentage, because higher coverage usually means less upside in strong rallies.
  • Judge it by long-term total return after fees, since a high payout with a falling unit price isn’t real income growth.

A 7%, 10%, or even 15% distribution yield can make a covered-call exchange-traded fund (ETF) look like an income machine assembled specifically for your retirement account.

Yet that distribution isn’t the same as a dividend from the underlying companies. It can combine dividends, option premiums, capital gains, and sometimes return of capital. Meanwhile, the fund may surrender part of its upside whenever markets rise quickly.

Covered-call ETFs can still be useful. I’d simply check three numbers before allowing the headline yield to make the entire decision.

ETF stands for Exchange Traded Fund

Source: Getty Images

Check distribution

A covered-call strategy owns stocks and sells call options against some of those holdings. The buyer pays a premium for the right to purchase the shares at a predetermined price. The fund collects that premium and can distribute the cash to investors.

Consider BMO Canadian High Dividend Covered Call ETF (TSX: ZWC). It owns dividend-paying Canadian companies and supplements their income by writing covered calls. Its recent $0.12 monthly distribution equals $1.44 annually. Near $22.77 per unit, that produces a forward distribution yield of approximately 6.3%.

However, the trailing 12-month yield was closer to 5.8% because ZWC paid smaller monthly distributions earlier in the year.

Which yield should investors use? Both provide useful information. The forward yield shows what the latest payment would produce if maintained for 12 months. The trailing yield shows what investors actually received over the previous year.

Option coverage

The next number is the percentage of the portfolio covered by written call options. Selling calls generates more premium income, but it can also limit more of the portfolio’s gains. If a stock climbs above the option’s strike price, the fund may have to sell it or settle the option instead of participating fully in the rally.

A fund writing calls against 25% of its portfolio retains more potential upside than one overwriting 75%, all else being equal. Strike prices and expiry dates also matter, but the coverage ratio provides a useful starting point.

Unfortunately, it isn’t always displayed beside the yield. Investors may need to open the ETF facts, prospectus, or latest holdings report. This trade-off is central to understanding how covered-call ETFs work. The premium isn’t free money. Investors receive current income in exchange for surrendering some possible future appreciation.

Total return

A monthly distribution tells you how much cash left the fund. Total return tells you whether the investment actually created wealth after including distributions and changes in unit price. Suppose a fund pays an 8% distribution while its unit price falls 6%. The investor hasn’t earned an 8% return. Before tax and reinvestment effects, the economic gain is closer to 2%.

That’s why I’d compare the ETF’s three-, five-, and ideally 10-year annualized total returns with a comparable fund that doesn’t sell covered calls. Check rising, falling, and sideways periods. Covered calls may shine when markets move sideways or rise gradually, because the fund can retain option premiums without surrendering enormous gains.

During a powerful bull market, the strategy can lag as winning positions are called away. During a sharp decline, premiums may soften the damage, but they won’t turn stocks into guaranteed investments.

Bottom line

Before buying a covered-call ETF, check its distribution yield and composition, option coverage, and long-term total return.

ZWC’s approximately 6.3% forward yield looks attractive, but the payment is only one part of the investment. Investors should understand how much upside the options may surrender, whether the unit price is holding up, and what remains after the 0.72% expense ratio.

Income matters, but the amount of your own capital still standing beside it matters considerably more.

Fool contributor Amy Legate-Wolfe has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

More on Dividend Stocks

Woman in private jet airplane
Dividend Stocks

Make $100 a Month Tax-Free: How Much to Invest in Diversified Royalty and Where

The TFSA is the ultimate investment account to place your money and earn tax-free income.

Read more »

man in bowtie poses with abacus
Dividend Stocks

Passive Income From Dividends: What Canadians Can Realistically Expect

Here's the actual dividend math the passive income gurus won't show you.

Read more »

Blocks conceptualizing Canada's Tax Free Savings Account
Dividend Stocks

RRSP, TFSA or Both? A Quick Guide by Income Level

Your RRSP and TFSA are complementing accounts that you can use to shield your income from taxes.

Read more »

Real estate investment concept with person pointing on growth graph and coin stacking to get profit from property
Dividend Stocks

Buying Your First Home? The $8,000 FHSA Deduction Most Renters Miss

An eligible renter's $8,000 FHSA contribution can save $2,400 at a 30% tax rate, with the purchase date guiding investments.

Read more »

A close up color image of a small green plant sprouting out of a pile of Canadian dollar coins "loonies."
Dividend Stocks

Building Your First Dividend Portfolio: Where Canadians Can Start

Here's my dividend stock picking guide, along with a dividend ETF to make it hands-off.

Read more »

gift is bigger than the other
Dividend Stocks

Enbridge vs. Telus: Which Pays More Reliable Income Through 2030?

Let’s compare Enbridge and Telus on financial performance, dividend history, yield, growth prospects, and valuation to see which offers the…

Read more »

Hand Protecting Senior Couple
Dividend Stocks

TFSA Income: 2 Top TSX Dividend Stocks to Collect Steady Cash in Your Golden Years

These top Canadian stocks have delivered steady dividend growth for decades.

Read more »

shopper checks her receipt
Dividend Stocks

The OAS Clawback Starts at $95,323: TFSA Withdrawals Don’t Count Toward It

The 2026 OAS threshold makes withdrawal planning valuable, with eligible TFSA cash avoiding an income increase that can trigger recovery.

Read more »