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May 1, 2021, 3:28 p.m. EDT

Want to increase your dividend income? The strategies of these funds can help you do it

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By Philip van Doorn

There are inflation worries as the U.S. economy recovers from its pandemic doldrums, but interest rates are still very low. This means many investors are forced to go to the stock market to generate income.

One way funds can generate extra income is by using option strategies. And some of those have led to returns that can appeal to growth investors.

Those strategies are used by covered-call ETFs, mutual funds and closed-end funds. Funds with high yields and the highest 10-year returns are listed below.

Covered-call strategies are the “predominant” options strategies used by mutual funds, according to Edward Szado, chair of the Department of Finance and an associate professor at Providence College in Rhode Island. Szabo and Keith Black, managing director of content strategy at the Chartered Alternative Investment Analyst Association (CAIA), published a study, “Performance Analysis of Options-Based Equity Mutual Funds, CEFs, and ETFs,” which listed the largest and oldest funds making use of options strategies. You can download the study, updated through 2017, here .

During an interview, Szado said his research focused on funds for which options trading is a “fundamental” part of the strategy, rather than something done occasionally. He also said there has been “significant growth among pension funds and endowments” in the use of options strategies.

According to Cboe Head of Index Insights Matt Moran, “the overall options industry had record volume last year, up 50% from a year earlier.”

“Many investors are buying individual call options,” he said.

Covered calls

A call option is a contract that allows an investor to buy a security at a specific price within a certain time period, while a put option allows an investor to sell at a specific price until the option expires.

A covered-call option is one that you can sell when you already own the shares. For example, if you own shares of a company that you purchased at price of $100, you might decide that you would be willing to part with the shares at a price of $110. You can sell an option to another investor, allowing them to buy your shares for $110 (the strike price) by a certain date. You receive a fee for selling the option. If the stock doesn’t rise above $110 by the time the option expires, you keep the fee and are free to write another option and generate more income. The more volatile the stock market, the more fee income is potentially available.

So a covered-call strategy enhances income. It can provide downside protection because you keep the income if your stock goes down in value, and can then write another covered-call option. But the risk is missing out on upside. Getting back to our $100 stock above, if you sell a covered-call option with a strike price of $110, and your stock doubles the next day, you get your $10 gain and your fee for writing the option, but lose out on $90 of upside.

A covered-call strategy may make for too much busy work for an individual investor or investment adviser. So there are plenty of exchange traded funds and mutual funds available that make use of those strategies.

ETFs

As their names make clear, exchange traded funds are publicly traded on stock exchanges. You can buy or sell at any time when an exchange is open.

An open-ended mutual fund is priced only once a day, when the stock market closes. You can only buy or sell shares at that time. A mutual fund’s share price is actually its net asset value (NAV), which is simply the valuation of all its assets divided by the number of shares.

So an ETF or closed-end fund has a share price and an NAV. Those prices are usually very close, but it is possible for an ETF to trade at a significant premium or discount to the NAV.

Click here for a more detailed discussion of how covered-call options work, including specific examples, and descriptions of two ETFs employing the strategies in different ways: The Amplify CWP Enhanced Dividend Income ETF /zigman2/quotes/208452653/composite DIVO -0.05% and the Global X Nasdaq-100 Covered Call ETF /zigman2/quotes/205578385/composite QYLD +0.40% .

The research by Szado and Black focused on funds that had been around for at least 10 years, through 2017. Some of the mutual funds they researched are listed below.

This first list includes the the largest ETFs employing options strategies, most of which are relatively new. The list excludes ETFs that are leveraged and those that are focused on specific commodities, such as silver or gold.

/zigman2/quotes/208452653/composite
US : U.S.: NYSE Arca
$ 37.54
-0.02 -0.05%
Volume: 277,145
Dec. 8, 2021 4:00p
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/zigman2/quotes/205578385/composite
US : U.S.: Nasdaq
$ 22.85
+0.09 +0.40%
Volume: 2.41M
Dec. 8, 2021 4:00p
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