Posted By High yield doesn’t equal better returns: Learn how covered call ETFs really work and why Total Return matters before you invest.
By Jimmy Xu, BMO Global Asset Management
(Sponsor Blog)
Covered call ETFs have become a popular solution for investors seeking cash flow, particularly in today’s uncertain market environment. With distribution yields that are often meaningfully higher than traditional equity ETFs, they can appear attractive at first glance.
But focusing on yield alone can be misleading.
To properly evaluate covered call ETFs, investors need to look beyond the potential yield and focus on Total Return: and understand how different strategies are implemented.
What are Covered Call ETFs?
Covered call ETFs generate returns by holding a portfolio of equities and selling call options1 on some or all of those holdings.
This strategy produces three sources of return:
- Dividends
- Net stock price appreciation from the equities held
- Option premiums2 from the calls sold
In exchange for that additional return generated from the option premiums, investors give up some upside potential if markets rise strongly: because the ETF may cap some upside participation at predetermined prices.
The result is typically higher cash flow with lower volatility, but more muted upside in strong markets.
The problem with Focusing only on Yield
One of the biggest misconceptions about covered call ETFs is equating high yield with strong performance.
In reality, yield is only one component of return. What ultimately matters is Total Return: the combination of dividends, premiums and equity price appreciation.
A strategy that pays a 10% yield but delivers little or no equity capital growth may lag a lower-yielding strategy over time; investors may also experience the net asset value (NAV) decline over time as distributions erode the initial investment. Conversely, a covered call ETF that balances premium generation with participation in market upside can potentially deliver stronger total outcomes.
That’s why evaluating these ETFs requires a broader lens asking questions such as: how much upside is being sacrificed? How sustainable are the distributions? What is the long-term return profile?
BMO’s Covered Call Approach: A more active Framework
Not all covered call strategies are built the same. BMO’s approach differs in two key ways:
- Active Option Management
Rather than mechanically selling calls on a fixed percentage of the portfolio, BMO takes a more active approach: adjusting the following based on timing and market conditions:
- The percentage of the portfolio covered
- Strike price selection (how far “out of the money” calls are written)
This allows the strategy to balance cash flow generation with participation in equity upside, particularly during stronger markets.
- Partial Coverage vs. Fully Covered
Some covered call ETFs write options on nearly the entire portfolio, maximizing distributions but limiting growth potential.
BMO strategies uses a range of partial coverage, meaning a portion of the portfolio remains uncovered which preserves the ability to participate in rising markets while still generating cash flow.
Our June 2025 Enhancement
In June 2025, BMO refined its covered call approach to further emphasize potential total return outcomes.
While the specifics vary by ETF, the changes broadly reflected:
- A more flexible coverage range, rather than static coverage targets
- Greater emphasis on out-of-the-money3 call writing, allowing for more upside participation
- A continued shift toward actively managing the trade-off between cash flow and potential growth
The goal was clear: move away from maximizing yield alone and toward delivering a more balanced cash flow & growth profile over time.
What Investors should Look for
When evaluating covered call ETFs, a few key considerations stand out:
- Total Return Track Record
This one is simple: Look beyond distribution yield and review long-term performance (ideally across different market cycles). If possible, review relative to the underlying equity exposure. A high yield doesn’t necessarily translate into strong Total Return.
- Coverage Level
How much of the portfolio is being written with call options? Higher coverage = more cash flow, but less potential upside. Lower or flexible coverage = more balanced return profile, over time. Understanding this trade-off is critical.
- Option Strategy (Active vs. Static)
Ask: does the ETF issuer’s strategy systematically selling options at fixed levels? Or actively adjusting based on market conditions? More active strategies may help adapt to changing environments: this is where an experienced Portfolio Management team can deliver value.
- Distribution Sustainability
Are distributions supported by total return, or from giving investors back part of their original investment? Consistently paying out more than the strategy generates can erode capital over time.
- Leverage
Leveraged covered call ETFs combine capped upside with amplified downside. They increase volatility, raise the risk of NAV decline which erodes the initial investment, and often undermine the very reasons investors use covered call strategies in the first place. For investors seeking income streams with controlled risk, leverage generally adds complexity and risk without improving long-term outcomes: making them a poor structural fit for most portfolios.
The Bottom Line
Covered call ETFs can be powerful tools for generating cash flow but yield alone doesn’t tell the full story.
Investors should focus on total return, strategy design, and long-term sustainability when evaluating these strategies.
BMO’s more active approach, particularly following the enhancements made in 2025, reflects discipline to balance income with growth potential, rather than maximizing one at the expense of the other.
In a world where income matters, but outcomes matter more, that distinction is critical.
Footnote:
1 Call option: A call option or a “call” gives its buyer the right, but not the obligation, to purchase an underlying asset at a set price (the strike price) before an expiration date.
2 Option Premium: the total amount that an investor pays the call writer for an option contract
3 Out-of-the-money: how far the strike price is set relative to the underlying stock price.
Jimmy Xu is Managing Director and Head, Liquid Alternatives, ETFs & Alternatives for BMO Global Asset Management. He joined BMO Global Asset Management in September 2023 responsible for building and managing Liquid Alternatives investment solutions. Previously, he was a Portfolio Manager at another Canadian Bank owned asset management firm, where he managed global multi-asset portfolios and cross-asset derivative strategies. Jimmy holds a Bachelor of Applied Sciences in Systems Design Engineering from University of Waterloo. He is a CFA Charterholder and a Commodity Trading Manager.
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This article is sponsored by BMO ETFs and is intended for informational purposes only. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment, tax, or legal advice to any party. Particular investments and/or trading strategies should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance. Past performance is no guarantee of future results.
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