Against a backdrop of higher valuations, covered call option strategies can provide opportunities to hedge positions and generate current income.

Covered Call Basics

Covered call strategies involve purchasing equities and selling a corresponding call option on those assets. A call option gives the buyer the right, but not the obligation, to buy a security at a pre-determined strike price within a given time frame. The call option strike price can be customized to the investor’s liking. It can be at the money (ATM) if an investor is willing to give up all of the security’s upside potential, or out of the money (OTM) if the investor would like to retain more of that upside potential. The tradeoff is that an ATM call option will generate higher premiums compared to an OTM call option.

The Global X Nasdaq 100 Covered Call UCITS ETF is an index fund that operates a rules-based investment policy, including a covered call option overlay. QYLD’s covered call strategy works in the same way that it might for an individual investor who wants to maintain holdings on a single equity and then write calls on that position to generate income. QYLD simply uses the broader Nasdaq 100 Index as its reference asset and writes its call options against the broader index in exchange for the options’ premiums.

Rather than purchase an ETF that tracks the Nasdaq 100, QYLD purchases the many components that comprise the index. As a result, the fund can maintain a high level of liquidity, and it is not subjecting itself to the additional expenses that might be associated with purchasing another ETF. Also, the strategy keeps the fund flexible in that it can purchase or sell the stock of individual companies in order to maintain an overall weighting that is as close as possible to its equity index, the Nasdaq 100.

QYLD operates a call-write strategy to cover 100% of its notional portfolio by selling Nasdaq 100 (NDX) call options that cover the entire Nasdaq 100, as opposed to writing call options on all the stocks that make up the index individually. The fund uses European style options that cannot be executed by the purchaser until the contract reaches its expiration date. These contracts are cash settled, so the fund maintains its systematic approach, writing at-the-money options monthly, and investors do not need to be concerned with how the fund can maintain its holdings at a similar weight to that of the index.

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Each month, the Global X Nasdaq 100 Covered Call UCITS ETF writes call options with strike prices that are at the money, which means that at initiation the strike price of the calls written is equal to the value of the underlying index. If a contract with a strike price that is precisely at-the-money is not available to be sold, the fund will write its call options at the closest possible strike price to the reference index’s value that is out of the money. The strategy allows the fund to attract the highest possible premiums for its written calls without selling contracts that are already in a position to potentially be exercised. From there, the fund proceeds to implement its policy of distributing half of the premiums it has received or 1% of the fund’s net asset value, whichever is lower. The balance of the premium is reinvested back into the fund.

How QYLD Might Perform in Various Scenarios

In theory, the premiums that QYLD receives position it to outperform the Nasdaq 100 most effectively when the index trades in choppy, flat, and declining directions.

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