Due to the high monthly distribution rate, investment funds are flowing into covered call exchange-traded funds (ETFs) utilizing short-term options, but as market volatility increases, warnings are emerging that caution should be exercised regarding the potential for principal loss. In particular, since most covered call ETFs are based on U.S. assets, they could be hit hard by sharp fluctuations in the U.S. stock market.
A covered call is an investment strategy whereby an investor holds shares and sells a 'call option' that gives the right to buy those shares at a predetermined price. Securities firms have launched a second-generation covered call ETF that utilizes short-term options to compensate for the limitations of covered calls that have restricted returns in a rising market. As a result, when the U.S. stock market continuously rose last year, investments surged into this product.
However, if the underlying asset does not establish a clear direction and fluctuates sharply, the situation changes. ETFs that use short-term options forgo upward gains and instead receive option premiums. Conversely, if the stock declines, they bear that decrease directly. Thus, in a highly volatile market, ETFs utilizing short-term options may fail to keep pace with rising stock prices and reflect declines when recovery is difficult, leading to a fragile distribution structure.
To achieve the target distribution rate, the principal may shrink. In many cases, investors receiving dividends from a covered call ETF continue to reinvest, meaning that despite receiving dividends during that period, they may need to sell at a loss later.
According to the financial investment industry on the 8th, the net worth of Mirae Asset Global Investments' 'TIGER NASDAQ 100 Target Daily Covered Call ETF' and 'TIGER S&P 500 Target Daily Covered Call ETF' was reported to be 657 billion won and 322 billion won, respectively. All are products less than one year old, but the combined net worth is approaching 1 trillion won. Recently, as tax benefits for overseas investments were reduced, investors appear to be turning their eyes toward covered call ETFs with short-term options that allow for tax-saving.
However, covered call ETFs are not products that guarantee the principal. In particular, when asset volatility is high, the risk of principal loss exists.
For example, let's assume the price of stock A fluctuates by 5% up and down every day. The covered call ETF utilizing short-term options will not be able to keep pace with that increase (+5%) on days when the stock price rises. This is because the ETF has forfeited the profit from the stock price rise by selling the call option in exchange for receiving the option premium. Conversely, on days when the stock declines, it will bear that decrease (-5%) directly.
In such situations, the premiums received from selling call options decrease, and the dividend resources also diminish. Additionally, the price of the underlying asset tracked by the ETF falls, ultimately leading to a decrease in the stock price, which is the denominator in the distribution rate (dividend/stock price). When following the same 10% distribution rate, if the price of the underlying asset falls, the actual dividends received also decrease. For instance, if one receives a dividend of 1,000 won at an average price of 10,000 won, and the value of the underlying asset declines to bring the average price down to 5,000 won, the dividend would also drop to 500 won.
Unlike the domestic stock market, products that include stocks listed on the U.S. stock market, which lacks a price limit system (±30%), require more caution. While it is an extreme case, the covered call ETF 'YieldMax TSLA Option Income Strategy ETF (TSLY)', based on Tesla stock, is a representative example. TSLY offers a high distribution rate approaching 80% by selling call options on all of the underlying asset, which is Tesla stock, to maximize premiums.
The problem is that each time there is an ex-dividend date or when Tesla's stock price falls, TSLY's price continues to decrease, while it is unable to benefit at all from price increases, making recovery difficult. This is the reason behind TSLY's downward trend. Even if the distribution rate is maintained when stock prices fall, the actual dividends paid are inevitably reduced, which could lead to principal loss.
Lee Sang-min, head of Pluto Research, noted, "Recently, covered call ETFs tracking highly volatile U.S. big tech companies have limited price increases while continuing to decline, making it difficult to recover the principal and also making it hard to guarantee ongoing dividends. If one tries too hard to maintain high distribution rates, they could reduce dividends while cutting into the principal, leading to the risk of capital erosion."