A Covered Call strategy for retirement

Investing Strategies Retirement Investing
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Let me start off by saying, I do have some investments in Covered Call ETFs. Some in a retirement account. But, mostly in a taxable investment account. Total investment in the segment currently, ~1.2%. At the peak, maybe 1.5%. I will come back to the discussion after I offer this use case.

Mr Berzins offers a Covered Call portfolio offering about $85,000 in annual income. The $575,000 portfolio is built around 6 Covered Call ETFs with allocations ranging from 13% to 19.1% on the six ideas.

Among my concerns with this portfolio

  • NEOS MLP & Energy Infrastructure ETF (MLPI) is less than 2 months old/young
  • NEOS Gold High Income ETF (IAUI) is a little over 6 months old
  • NEOS Nasdaq-100(R) ETF (QQQI) is only about 2 years old
  • NEOS Real Estate High Income ETF (IYRI) is about a year old
  • NEOS Russell 2000 High Income ETF (IWMI) about 2 years old

The bigger issue for me is that a majority of this portfolio is new or fairly new, and has not really been tested in various market conditions. The other issue is dependency on one entity (NEOS). Five of six ETFs, each new or fairly new, and managed by one entity, NEOS, is a concern. My feeling is that while the author might be arguing that this basket has some defensive aspects, it still is a reach for yield.

My covered call ETF investing has mainly been with YieldMax. YieldMax ETFs tend to provide a high yield. But, the price deterioration on the ETF can sometimes be quite ugly. So, I am learning YieldMax ETFs might be better suited for a taxable ac, where one can utilize the capital losses in some fashion. I have also invested in QYLD (managed by Mirae Assets). This ETF is similar to QQQI (mentioned in the article). Lower income than the YieldMax names. But the trade-off is less price deterioration on the underlying ETF. I do feel some Covered Call exposure can be helpful to a retirement portfolio. But even when I’m close to retirement, my target will likely not be anywhere close to $85K from a Covered Call basket.

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Hohum,

You mentioned two CC ETFs, QYLD and IQQQ. Their underlying is QQQ. So, run this exercise. Go to Yahoo Finance and pull a year’s historical data for each, which is presented in two formats, one as the prices actually occurred and one with the divs backed in to create an “adjusted” price.

On 01/17/25, the adjusted price for IQQQ was 38.52, and the adjusted price on 01/16/26 was 44.96. Thus, the total gain to an investor from owning IQQQ over that one-year holding-period was 16.7%. For QYLD, the one-year total gain was 8.4%, and for QQQ the total gain was 19.7%.

Reminder: Total Gain = Divs rec’d plus or minus the diff between the opening price and the closing price over a given holding-period divided by the actual opening price.

Ques: “Why does the derivative typically offer less return than the underlying?”
Ans: “Them marketing the derivatives are taking their cut before distributing the profits they might have made from writing calls on the underlying.”

In short, covered call ETFs are yet another Wall Street scam that targets naïve investors who can’t do basic, 4th grade math, or, more kindly, are content to receive a periodic income stream on which they likely have to pay ordinary income taxes rather than hold for a year and pay a lower cap-gains rate on their likely higher profit.

In fact, when that exercise in run on the pair IQQQ vs QQQ, I estimate the after-tax profit over a one-year holding period for IQQQ to be 11.6% and for QQQ (which does pay small quarterly divs and which I taxed at ord-inc rates) to be 16.6%, or roughly 30% more money in the pocket after taxes from holding the underlying directly rather than messing with a derivative of the underlying.

Standard Caveats: Every one of my assumptions could and should be challenged, and my math should be double-checked. But… if my numbers are correct, the necessary conclusion is that CC ETFs are yet another Wall Street scam that mostly benefits its promoters, not its participants.

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@Arindam - I didn’t mention IQQQ. You introduced a very different ETF into the discussion. The article mentions QQQI and I have a position in QYLD.

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Follow-up.

Doing the math for comparisons between CC ETFs and their underlying is straightforward but tedious. So here’s a simpler solution. Go to a site like Bar Chart and set up a chart using one-week bars, with divs backed in, and scaled in percentages.

Here’s what IQQQ looks like. Note the highlighted number at the right–hand edge of the chart. That number is the estimated gain an investor would have for a one-year holding period.

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Here’s a chart for the underlying of IQQQ, which is QQQ, done in the same format.

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So, do you want to earn 27.81% from owing a derviative like IQQQ and pay ord-inc taxes on the bulk of that gain, or do you want to earn 30.48% from owing the underlying of that derivative and pay the lower cap-gains rate on the bulk of that gain?

Again, this question needs to be asked: “Why is there a difference in performance results between a structured product and an unstructured one?” Simple. Them doing the structuring want their cut. That’s why they slice and dice, and that’s why things like bond funds will always under-perform what an investor her or himself could achieve by holding those bundled assets directly.

Same-same with ‘target maturity’ funds and many country funds, sector funds, and industry funds. You’ve gotta pull the schedule of holdings and ask yourself whether the convenience of Wall Street’s packaging is worth paying the price they are asking in the form of their management fees. Sometimes, it makes sense to do so. Sometimes, it doesn’t. It’s your job as an investor to do your research and to make a decision that best reflects your means, skills, interests, goals, and obligations.

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Hohum,

My dyslexia in swapping in IQQQ for your QQQI makes not a whit of difference in my argument. The 1-yr total gain (with divs backed in) for QQQI was 17.5%, an (-11%) underperformance compared to the underlying’s total gain of 19.7%. That’s not a substantial haircut. But such differences can quickly have a huge negative impact across a typical retirement portfolio.

I’ve done these CC ETFs vs their underlying comparisons on dozens of pairs and have yet to find a single one where buying the structured product offered equivalent or better gains on a pre-tax basis.

Why did I run the numbers? Because a friend who should know better is buying them by the multi-thousands of dollars worth, because he likes to have a weekly inflow of divs.

Also, I ran the numbers because I, too, was sucked into the scam until I started realizing that I was trading the elephants of price appreciation for the rabbits of dividends. I still own a couple CC ETFs linked to gold. But I got rid of the rest of the several dozen I was experimenting with.

Can CC ETFs be traded in and out of to avoid price share declines instead of just bought and held? For sure. But if one is going to trade, why not just trade the underlying instead of adding the complication of having to deal with record dates, ex-div dates, etc.?

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@Arindam- The difference between IQQQ and QQQI might not make a difference - fine.

But you using the underlying QQQ is also irrelevant. In using the underlying QQQ, you are assuming every investor wants growth. Do you think a portfolio for a 30 - 35 year old will be the same as that of a 65 - 70 year old? Are you saying an investor cannot have a requirement other than growth? If so, I will tell you there are investors who are looking for something other than growth i.e. income. They will sacrifice some, to “a lot” of growth to get that income.

Did you really need to invest in several dozen Covered Call ETFs to gain enough insights on the investment type? Can see you wandering around with a hammer, “Aha! another nail”, “that looks like a nail (might as well be a nail - whack!)”
You are correct that Covered Call ETFs are more complicated. Those payouts are sometimes strictly not ordinary dividends. There might be some capital gains (LT or ST) and/or return-of-capital mixed in.

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Hohum,

The fact that the total return offered by a CC ETF can be benchmarked against the total returned offered by owning its underlying is NOT “irrelevant”. The nearly always inferior performance of the derivative is the only fact that matters.

Doing those kinds of comparisons isn’t an original idea. Legendary investor, Peter Lynch, made a similar argument many years ago. He scoffed at the idea that them approaching or in retirement should rotate into bonds instead of continuing to own stocks, because they “now needed income”. He said, “If it’s income you need/want from your portfolio, then sell some stocks. Your gains will be higher, and the tax impact lower.”

Yes, bonds can have a role to play in building portfolios, no matter one’s age, and I own a lot of them. In fact, for many years, I ran an all-bonds portfolio that invested across the yield- curve and up and down the credit-spectrum. But that was then, and this is now when doing things like buying XRX’s 8’s of '27 at 34 and being marked to market a couple years later at par was possible, all the while receiving a current-yield from the coupon of 23.5%.

What kinds of returns did the stock guys end 2009 with? The same money I made from my all-bonds portfolio. Why? Because I had been doing the Ben Graham thing as markets crashed and was in there buying what should have been bought, when it should have been bought.

So don’t try to tell me about “income” vs “growth”. I know both those games, and I know that CC ETFS suck majorly for trading the elephant of share price preservation/appreciation for the rabbit of a bit of periodic, but never guaranteed, ordinary-income.

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@Arindam- I think you are missing my point - but whatever. In another thread, you had advised someone “There are no roads, but by walking”

You used plural - roads. You are on a road. Maybe I am on a different road. What I hear is you trying to convince me there is only one road. And I don’t think there is a single road.

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Hohum,

I agree that each investor must make the investment choices and portfolio decisions that best suit their own means, needs, goals, interests, skills, opportunities, and obligations.

But when someone pitches CC ETFs as possibly being a possibly good path to creating an income stream, I have to object and point out that the math doesn’t support the choice.

So, if it’s an income stream one wants, as well as to reduce the overall volatility of the portfolio, what might be a safer, more assured means to obtain an income stream? Exchanged traded debt securities with a fixed coupon and nearby maturity.

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@Arindam In the initial post, I mentioned that I had an allotment to Covered Call ETFs and two data-points on sizing. I also pointed out, that down the road, I don’t see myself using the Covered Calls ETFs for anything close to the $85K that Mr Berzins is “projecting” for his portfolio. If that is too difficult to grasp, that’s on you.

Regarding Exchange traded debt securities … Um! I had to go look it up. I did not initially process that term as “baby bonds”. Interestingly, “baby bonds” are a more recent addition to my investment tool chest. Have just one investment in baby bonds (RWTO), and will likely just let it percolate for a few months.

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Ah, yes. RTWO. It’s in my portfolio. The 9’s of ‘29. Closed Friday at 25.06, for a CY of 8.89% and a YTM of 8.92%.

That, to me, makes much more sense than messing with CC ETFs, and I own pieces of most of the issuers, because I prefer a scatter gun approach rather than focused bets.

Also, as I implied elsewhere, part of the attractiveness of such securities is their lesser volatility compared to some of the stuff I own or some of the trades I do.

The easiest way to find exchange traded debt is to use Quantum Online’s scanner, export the list into a spreadsheet, do CY and YTM calcs, and then discard anything that is paying too much –i.e., priced worrisomely low– or not offering much return over far safer alternatives.

If maturities are kept fairly nearby, one’s holdings don’t result in a negative return after taxes and inflation, as do longer term bonds. Those 20 to 30 years out will always result in a negative return even at a reasonable inflation rate such as 6% and an ord-inc rate of 25%. That’s just the math of bonds.

PS. How can a bond be said to be "paying too much”? Simple. That projected high return isn’t likely to be achieved often enough to be worth the risk.

Explanation: Not all bonds are rated by the credit agencies. Those that are are said to carry an ‘agency-assigned’ rating (which might be a split rating). Agency-assigned ratings should never be trusteed. As any who watched The Big Short or read Lewis’ book knows, the rating agencies can be bribed or the issuer can cook its books, and this is more likely to show up at the boundary between invest-grade and spec-grade. (Many potential institutional buyers are restricted to holding invest-grade.)

However, investors have an easy workaround. Rather than repeat the green eye shade work the rating agencies do in an effort to confirm its accuracy, why not let “the market” itself rate the bond through its pricing of that bond? That pricing creates a ‘market-implied’ rating, which, again, should never be trusted entirely, but can often be a tipoff when things aren’t as they appear to be, and the bond really is a piece of trash that should be avoided.

Now comes a tweak to the previous word of caution. If one wants to mess with high-yield bonds, aka, junk bonds, and I used to buy a lot of them, then the key to survival in the game is to size positions sensibly instead of betting the farm. Thus, one buys an equally-weighted basket of high-yields with the full expectation that some will default and will end up in Ch 11 where the workout could be pennies on the dollar or nothing at all. However, if the bonds that do mature for you offer a return that can absorb the losses you do suffer AND offer a prem to buying a basket of safer debt, then you won the high-yield game.

Thus, I’d suggest allocating 1/2 the total bond allocation to 'defensive’, 1/3 to ‘enterprising’, and 1/6 to 'speculative’ (all terms borrowed from Ben Graham and fully explained in his classic intro to value investing.) Such a 3:2:1 allocation means you’re likely to achieve a decent return and to stay out of unnecessary trouble.

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To those with an open mind on the Covered Call ETFs. The second half of the article covers the different types of Covered Call ETFs, and a pluses and minuses of Covered Call ETFs