In uncertain markets, many investors look for ways to generate income while managing risk. One approach that combines both goals is an options strategy called a covered call.
How It Works
A covered call strategy involves two components:
- Owning the underlying securities (such as a basket of equities or an equity ETF)
- Selling call options on those holdings to collect option premiums.
The call options give another investor the right — but not the obligation — to purchase the securities at a specified price – the strike price – within a certain time frame. In exchange, the call writer immediately receives the premium from that transaction.
If the market price stays below the strike price, the option expires, worthless, and the investor keeps both the underlying holdings and the premium. If the market price rises above the strike price, the investor may be required to sell the holdings at that strike price, capping potential upside in exchange for the income received.
Why Investors Use It
Covered call strategies are often used by investors seeking:
- Regular income from option premiums
- Smoother returns compared to owning equities alone
- Partial downside cushioning, since the premium can help offset small market declines.
However, the trade-off is that these strategies limit upside potential if markets rise sharply. Investors should also understand that options involve risks and long-term costs and may not be suitable for all portfolios.
Several funds in Canada use covered call strategies within diversified portfolios. For example, the JPMorgan Equity Premium Income ETF – JEPI-CA – employs an actively managed approach that seeks to deliver monthly income and equity exposure by combining stock selection with a covered call overlay.