Covered call ETFs: A primer
Learn what covered call ETFs are and how they work.
CIBC Investor’s Edge
Jan. 28, 2026
6-minute read
Covered calls are a potential strategy for stock investors who want to generate income from their portfolio. In recent years, covered call ETFs have become an increasingly popular way for investors to add a covered call strategy to their portfolio. To explain covered call ETFs, let’s start with some terms.
Exchange traded fund (ETF)
An ETF can hold a variety of stocks, bonds or other assets like a mutual fund, but trades on a stock exchange like a stock. An ETF enables investors to hold a broad range of stocks or a specific investment strategy — for example, without having to select each individual investment.
Call option
This is a financial contract that gives the buyer the right — but not the obligation — to buy a stock at a specific price, within a specific timeframe.
Here are some key terms related to call options.
- Premium: The amount an investor pays when buying a call option, or the amount an investor receives when selling a call option.
- Strike price: The agreed price at which the call option holder can buy the stock.
- Expiry: The last date when the call option holder can buy the stock.
- Assignment: When the call option seller must sell the stock to the call option buyer, at the agreed price.
Covered call ETFs
These ETFs sell call options on the stocks in the portfolio and collect the option premiums, which can be distributed to investors in the fund.
How do covered call ETFs work?
A covered call ETF starts with a portfolio of stocks and adds an option strategy to generate income. Here’s what happens behind the scenes, based on the example of covered call ETFs at CIBC Asset Management.
1. Own the stocks. The ETF holds a portfolio of high-quality stocks, giving you exposure to equity markets.
2. Set the strike price. The portfolio manager sets the strike price — a pre-determined price at which certain stocks can be sold.
3. Sell the call options. The portfolio manager sells call options, giving other investors the right to buy the stocks at the strike price, by a specific date.
4. Earn the premium. The ETF collects premiums — a source of cash flow — from selling the options. These premiums are distributed to investors as part of the ETF’s income.
Performance of covered call ETFs in different market conditions
A covered call strategy involves holding stocks and selling call options against the stocks. Imagine this situation:
- A stock is trading at $100.
- A covered call investor — the call option seller who also owns the stock — sells a call option for $2, at a strike price of $110.
- The call option buyer has the right to buy the stock if the stock price hits $110.
- The covered call investor keeps the premium of $2, regardless of what happens to the stock price.
Based on this situation, here’s how the covered call strategy could play out in three different scenarios.
Scenario 1: Large up move — Stock price rises to $120
The covered call investor has capped their gain. The call option buyer can buy the stock at the option strike price of $110, which makes sense if the stock is trading at $120. As a result, the covered call investor is forced to sell the stock at $110. They get a $10 gain on the stock plus the $2 option premium, for a total gain of $12. If they had held the stock without a covered call, they could sell at $120 and collect a $20 gain. The covered call investor has sold off the upside of the stock above the strike price, in return for collecting the option premium.
Scenario 2: Moderate up move — Stock price stays within range of $100 to $110
This is the ideal scenario for the covered call investor. Say the stock ends up at $110. The covered call investor gets a $10 gain on the stock, plus the $2 option premium, for a total gain of $12— without giving up any upside. Nice work if you can get it!
Scenario 3: Down move — Stock price falls to $80
The covered call investor has slightly reduced their loss. The covered call investor loses $20 on the stock but still gets the $2 option premium, for a total loss of $18. The option premium is $2, regardless of whether the loss is $20, $40 or $60. This shows that the covered call strategy can provide a buffer against small losses but relatively little protection against large losses.
These examples are based on a covered call on a single stock. Things can work a bit differently when an ETF holds, say, 50 or 100 stocks, although the intuition is the same — a moderate increase in the stock price is typically the best outcome for the covered call investor.
Potential benefits of covered call ETFs
Generate income
Premiums can provide a source of monthly income for the ETF, potentially enhancing cash flow for income-focused investors.
Reduce portfolio volatility
Premiums may help reduce the impact of price swings, potentially smoothing out equity returns for risk-averse investors in a covered call ETF.
Stay invested
The ETF continues to hold stocks without needing to sell, helping growth-focused investors stay invested for long-term potential.
Support retirement income
Premiums can enhance dividend strategies by offering an additional source of income for covered call ETF investors who are retirees or those drawing down their savings.
Potential risks of covered call ETFs
Sell off the upside on large up moves
With covered call ETFs, the portfolio manager has effectively sold off the upside of the stock above the strike price. If the stocks have a sudden or large gain in price, the covered call investor would capture part of the gain but would lose any gain above the strike price.
Provide limited protection on large down moves
Covered call ETFs may provide a meaningful buffer against small down moves in stock prices. However, the option premium is fixed. As a result, the larger the loss on the stocks, the less protection the premium income provides.
Rely on the portfolio manager’s expertise
In order to implement a covered call strategy, the ETF portfolio manager has to closely watch the price action of the fund’s stock holdings and constantly manage options as they expire. As a result, there can be gaps between what a covered call strategy could achieve, versus what it actually achieves.
May target very high income and end up being very volatile
Not all covered call ETFs target moderate levels of income based on a diversified portfolio of stocks. Some target very high levels of income based on a limited number of stocks, sometimes even a single stock. This may introduce much higher levels of volatility than an investor would expect from an income-focused strategy.
Choosing covered call ETFs
CIBC Investor’s Edge offers a variety of screening tools, making it easy to find the right ETF. Maybe you already know the fund company, so you can search by their name. Also, most covered call ETFs use “covered call” in the name of their fund, so you can search that way too.
