Single stock and covered call come together in ETF line

Advisors reflect on effectiveness of 'volatility buffer' covered-call ETFs, with few single-stock versions available.

A forthcoming ETF suite is aiming at the crossroads of two investing trends currently having their moments: single-stock products and covered-call strategies.

That appears to be the heart of the Rex IncomeMax ETFs — a line of 17 funds, each of which gives the covered-call treatment to a specific security. The stocks are big names, ranging from Amazon to Disney, but some of the products focus on third-party funds, such as the VanEck Semiconductor ETF.

The firm, Rex Shares, made an initial filing for the products with the Securities and Exchange Commission earlier this year but on Thursday filed an update that included more complete information, such as fees, and indicated the ETFs could launch within 75 days, if approved.

Single-stock ETFs began appearing on the market a year ago, accompanied by a warning from SEC Commissioner Caroline Crenshaw for the masses: Although they focus on individual securities, they are complex products, providing leveraged or inverse exposure, that casual investors should avoid dabbling with.

Although covered-call ETFs have been around for years, they came into vogue last year as stock and bond prices were tanking. While the products are generally designed to help limit downside, they also have lower positive returns than one would get with direct exposure to a security.

“Advisors and investors have increasingly become comfortable with covered-call ETFs. They provide some downside protection, enhanced income even if the equity does not pay a dividend, and ease of use,” Todd Rosenbluth, head of research at VettaFi, said in an email. “The most popular funds, like JEPI, QYLD and DIVO, own options and a broad range of stocks. However, we have seen growing supply of single security focused, options-based ETFs.”

That is where the Rex IncomeMax ETFs come in. Those funds would invest in put and call options contracts for exposure to individual securities, with premium income then going to Treasuries “and other money market instruments,” the prospectus reads. The options contracts provide “synthetic long exposure to the share price returns,” current income from covered-call option premiums and a limit on participation in share-price gains.

The ETFs are advised by Rex Advisers and sub-advised by Vident Asset Management. Fees for each ETF are 99 basis points.

Currently, there are not many covered-call ETFs on the market, with a total of at least 23, representing about $52 billion, according to data from Morningstar Direct. The oldest product, the iPath CBOE S&P 500 BuyWrite ETN, dates to 2007, and most of the covered-call ETFs on the market were launched within the past few years.

But the biggest, by far, is the JPMorgan Equity Premium Income ETF (JEPI), which launched in 2020, and as of the end of August represented $29.4 billion, according to Morningstar. That ETF saw $12.9 billion flow into it last year, and to date in 2023 it’s raked in another $11.4 billion.

Sean Rawlings, founder of WealthBound Advisors, a new RIA in Arizona focused on high-net-worth millennials, began using JEPI last year. Covered-call ETFs “work best during time when the stock market is going sideways or falling” but can also provide income in the right circumstances, Rawlings said in an email.

“This position works best in my opinion as a ‘volatility buffer’ allowing clients to lower the volatility or beta within their portfolio compared to the S&P 500,” he said.

Another advisor, Nick Rygiel, said he favors the JPMorgan Nasdaq Equity Premium Income ETF and the Innovator Premium Income 10 Barrier ETF, the latter of which launched in July.

“I find the InnovatorShares ETFs more interesting (like TJUL and JULD) as it allows aligning specific risk-defined outcomes for a client,” Rygiel said in an email. “I use Interactive Brokers [for] creating covered call/collar strategies via options instead of single stock ETFs. Altruist is great for ETF models and risk-defined investment allocations.”

While most would likely agree that the products’ use is limited, some advisors say they are best avoided.

“The investment management industry is adept at inventing products and creating new and creative ways of pitching them to the investing public at large. I am not and will not ever use covered-call ETFs (or covered calls) as a strategy for myself or for client portfolios,” Will Brennan, founder of Park Hill Financial Planning & Investment Management, said in an email. “There are far better and more cost-effective means of managing single-stock or concentration risk … [such as] selling portions of the individual stock and/or using a custom, direct index portfolio to build a completion portfolio around the concentrated stock position.”