In recent years, preferred shares (preferreds) have become increasingly popular as investors strive to meet their income needs. Preferreds combine the characteristics of both equity and fixed income securities and are chosen by investors to provide their unique balance of security and yield.
Not all preferreds are equal when it comes to interest rate sensitivity. When rates rise, this could place pressure on straight perpetual preferred shares, which are more interest rate sensitive given their long duration. Rate reset preferred shares, on the other hand, are more adaptable in a rising rate environment since their dividends are reset on a periodic basis, adjusting to reflect the current interest rate environment.
The rate reset market has grown significantly in recent years - new issuers and new issues. ETFs are now able to deliver convenient and well-constructed portfolios built around rate reset preferreds.
BMO ETFs covered call strategy is implemented by writing a call option contract while owning the equivalent shares of the underlying stock. The purpose of the strategy is to provide additional income and reduce the risks of stock ownership.
Instead of stretching for additional yield with fixed income investments (and increasing risks), the covered call strategy effectively creates an additional income stream from equity investments. Additionally, it also has the added benefit of reducing equity risk making it a valuable portfolio construction tool.
BMO ETFs covered call strategy generates income from two sources. First and foremost, is the dividend yield from the underlying assets. Next is the overlay of premium income generated from selling the call options. By already having a strong income base from the underlying, we can employ a lighter touch with the call option overlay to better protect investor's capital.
BMO ETFs sell out-of-the-money call options which cap the return of the portfolio at the option strike price until the option expires. For BMO ETFs, option expiries are generally 1-2 months out.
Historically, covered call strategies have provided similar overall return to the underlying portfolio with a significantly lower risk level.