MW This investing strategy has held up well during stock-market turmoil. It pays you to wait.
By Philip van Doorn
Monthly income that rises when stock-market volatility is high can help you ride through financial storms
There's one thing in common when it comes to the various approaches to investing: What should always be foremost on your mind is your set of goals. Is long-term growth most important? Do you need income now? One particular diversified strategy for stocks is designed to provide you with a relatively high level of monthly income while capturing less downside when the broad market tumbles. There is a price for the combination of income and lower risk, but you might find it worth paying.
Getting back to goals, if your objective is to build a nest egg over decades by pouring money every pay period into diversified equity funds within a tax-deferred retirement account, broad declines for stock prices can enhance your long-term returns. When the market sinks, you pay lower prices.
It's not fun to wait through down periods for stocks, but you need to expect them. The reasons for the declines will vary. Examples have included the dot-com bubble that began to deflate in 2000, the financial crisis of 2008, the early phase of the COVID-19 outbreak in 2020, the broad decline in 2022 driven by the Federal Reserve's aggressive interest-rate increases to fight inflation, and now President Donald Trump's broad array of tariffs. But the market has recovered from every previous decline.
One can never predict how long a market recovery will take or when it will begin. For example, after the index peaked in March 2000 before the dot-com bubble began to deflate, it didn't return to that level until May 2007. This is why John Buckingham, editor of the Prudent Speculator investing newsletter, has repeatedly stressed that "time in the market trumps market timing."
In a note to clients on Monday, Buckingham wrote that since the Prudent Speculator was launched in 1977, there had been 39 corrections (declines of 10% or more) for an average decline of 18.01%, but also 39 rallies of 10% or more, for an average gain of 40.69%
Despite all the corrections, if we go back 30 years, the SPDR S&P 500 ETF Trust SPY - the first index exchange-traded fund, which tracks the S&P by holding all of its stocks - has had an average annual return of 9.9%, with dividends reinvested, according to FactSet.
All subsequent returns in this article include reinvested dividends.
Covered-call ETFs for income and lower risk while still pursuing growth
There are various ways exchange-traded funds can use covered-call options to increase income for their shareholders. First, let's explain how the strategy works with a few definitions and a simple example.
A call option is a contract that allows an investor to buy a stock at a particular price (called the strike price) until the option expires. A put option is the opposite, allowing the purchaser to sell a security at a specified price until the option expires.
A covered-call option is one that an investor can write when they already own a stock. The strike price is typically "out of the money," which means it is higher than the stock's current price.
Here is an example for an individual stock: Let's say you hold 100 shares of a stock trading for $100 a share. You like the stock but would be willing to part with it for $110. You sell a call option for a fee to an investor who believes the shares will trade much higher than $110 before the option expires. If the stock moves above $110, you are forced to sell it for $110. You keep your option fee, but now need to find something else to invest in. If the stock doesn't rise above $110 before the option expires, you still keep your option premium and can write another call option.
Option prices fluctuate continually, but in general, premiums are higher during periods of greater volatility. In the above example, the investor has enjoyed some downside protection - the premium income - but has given up the additional upside potential beyond the $110 strike prices.
Below are two examples of exchange-traded funds that follow covered-call strategies in different ways. Before looking more closely at them, let's look at three performance charts.
First, year-to-date returns for the S&P 500 and the two ETFs:
Through Friday, the S&P 500 was down 13.4%, while the Amplify CWP Enhanced Dividend Income ETF DIVO was down 5.7% and the JPMorgan Equity Premium Income ETF JEPI was down 7.7%.
Now let's see how all three fared during the S&P 500's last down year in 2022:
We have just come through what could only be called a raging bull market in 2023 and 2024. So let's take a look at how all three have performed from the end of 2021 through Friday:
The results are mixed, but the covered-call ETFs have provided investors with a smoother ride than the index has. Of course, a sharp decline will hit all three hard in the short term. But the covered-call funds, with their higher income, might make up lost ground as you wait for the S&P 500 to recover.
DIVO
The strategy followed by the $3.8 billion Amplify CWP Enhanced Dividend Income ETF DIVO is to hold 20 to 30 dividend-paying stocks selected for quality, along with shares of other ETFs, while writing covered-call options as opportunities for attractive premiums present themselves. The fund has a five-star rating (the highest) within Morningstar's "U.S. Fund Derivative Income" category. It is managed by a team led by Kevin Simpson, the founder and chief executive of Capital Wealth Planning, which subadvises for the fund, might decide not to write any covered calls.
As of April 7, DIVO had covered calls on eight of its 23 individual stocks. The fund's annualized distribution rate was 4.85% on Monday, and Amplify ETFs estimated that returns of capital made up about 67% of distributions.
The return of capital means investors' own money is being sent back as part of the distribution. This practice might be surprising at first, but it offers tax advantages. Instead of distributing all gains and option premium income, much of those tax consequences can be avoided when an ETF reinvests those proceeds immediately. Instead of realizing and distributing capital gains, the fund can return some of the investors' capital as part of the distribution to lower investors' current taxable income. This has the effect of lowering the fund shareholder's cost basis. Eventually, deferred capital-gains taxes must be paid, but not until you sell your shares for a profit.
Individual stocks held by DIVO, on which it had written covered calls as of Monday, included American Express Co. $(AXP)$, Verizon Communications Inc. $(VZ)$, Home Depot Inc. $(HD)$, Salesforce Inc. $(CRM)$ and TJX Cos. $(TJX)$.
Despite the variability of option income and the returns of capital, the bottom line is that DIVO's total return has been the best on all of the above charts.
JEPI
The JPMorgan Equity Premium Income ETF JEPI was established in May 2020, but has already grown to over $40 billion in assets under management. It is rated four stars (out of five) by Morningstar. The fund typically holds about 100 stocks highly rated by JPMorgan Chase's equity analysts, with a maximum portfolio weighting of 2% for each holding.
It pursues the covered-call strategy by purchasing equity-linked notes, rather than by writing individual options. This means the income generated is ordinary income; there is no return of capital. The fund quotes a 30-day SEC yield of 8.76%, but has had a rolling 12-month distribution yield of 7.51%.
Option premiums and income on the equity-linked notes employed by JEPI can increase dramatically during periods of high volatility for stock prices. At the end of 2022, JEPI's yield was more than 12%. Hamilton Reiner, one of the fund's managers, discussed its strategy in an interview with MarketWatch early in 2023.
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-Philip van Doorn
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April 07, 2025 10:21 ET (14:21 GMT)
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