XYLD: The S&P 500 Is Begging You To Consider Covered Call ETFs, But JEPI Is Not

Exchange-traded funds, or ETFs, that write covered calls are emerging as a go-to core piece of retirement income portfolios, as well as for more risk-intolerant (e.g., conservative) investors. In my article back on August 30, I introduced an approach I take to managing around a core covered call ETF position. And the longer the stock and bond markets’ recent rangebound trading continues, the more attractive covered call ETFs look. Returns will be more of a grind-it-out process in the future, as compared to the zero-interest-rate-policy (ZIRP) era we just had.

This “calls” for a modern approach (pun intended): covered call ETFs at the core

Thanks to many outstanding and well-meaning comments on that earlier article, I have a good idea what to focus on next. So, let’s take that initial discussion a step further. Because it is now obvious to me that the Seeking Alpha audience is already highly-invested in this strategy, and there is strong interest in learning more, including ways to complement that covered call position, to make it a true anchor of a long-term portfolio.

This article focuses more on process and less on picks. In other words, my goal is to show how to apply the strategy I use around covered call ETFs. Know that it can be used with any covered call ETF. And with more than 200 ETFs now using options to protect and/or enhance their returns, I think this process is a timely one to share. It is based much more on a forward-looking view of markets that is lower-return/higher risk than what we have had the past 15 years, where the SPDR® S&P 500 ETF Trust (NYSEARCA:SPY) produced a superb annualized return of 11%.

But the past is the past. We can’t own it. What we can do is to evaluate the market we have now, and contemplate and plan for future episodes of both harsh declines in the broad market, and periods of high return in bull markets. Because most, if not all covered call ETFs can be great core investments, but a little help around the edges can make them even more powerful core investments.

Grind it out!

In a “grind out returns” environment as opposed to what we’ve had for most of the period since the Global Financial Crisis in 2008, complicated by the mixed blessing of higher interest rates, yet higher inflation and exploding consumer and government debt, I see this as as potential modern “core and satellite” approach for investors. It certainly has been for me, as I honed it during the three years since I sold my investment advisory practice after 27 years in that industry, to “retire” and focus on investment research and investor education, with a focus on making ETFs easier to analyze, understand, and create effective portfolios with.

So, let’s quickly review where the stock market appears to be now, and then I’ll show a somewhat generic example of how to take that next step, use the covered call ETF as the portfolio core, but add a couple of pieces around it that have made me more comfortable holding them for longer periods of time.

The “Stuck Market” and the opportunity it brings for income and risk-management

The stock market is more like a stuck market. The broad market indexes are caught in a trading range. The same goes for many individual stocks and sectors. The middle part of this year brought a furious rally, driven by the Artificial Intelligence craze, the Fed flooding the system with liquidity to help regional banks get off the mat, among other factors.

But as the S&P 500 and Nasdaq sped toward their all-time highs, the train slowed down. It is as if the market feels a true breakout is unwarranted, but a steep decline is not yet justified. Given the explosion of covered call ETF issuance, and the spike in interest in them on this platform and elsewhere, this market segment is evolving into a vital category for income investors.

A trendless market is a good time to own covered calls, since you essentially are getting paid to wait…for something, anything, to happen. If the market goes up, you likely make just a small additional sliver of return, since you exchanged most of the upside for that regular covered call option income received, in most cases monthly, from the ETFs.

But there’s another great reason to look closer at covered call ETFs. The stock market’s dividend yield is near its lowest point in 30 years. A 1.5% yield on the S&P 500, shown in the above chart, and generally suppressed dividend yields across quality companies, reflects the dominance of growth stocks in that index after years of trouncing value stocks. But it also could be the result of companies favoring stock buybacks over distributing more dividends, for a long time now.

Take a close look at that graph above. 1.54% yield. That’s the lowest S&P…