Why a focus on ‘leaders’ works in Call Option ETFs

By Paul MacDonald, CFA

(Sponsor Content)

Harvest ETFs Chief Investment Officer explains why the independent ETF firm focuses on 20-30 ‘leaders’ in its call option ETFs.

Harvest’s call options ETFs are built through a structured process. Portfolio managers begin by identifying an industry, sector or theme with long-term growth prospects such as healthcare, technology, or utilities. They then identify and select between 20 and 30 leaders: large-cap companies with significant financial reserves and market share. The portfolio managers then apply Harvest ETFs’ active & flexible call option strategy to the ETF holdings to generate consistent monthly income for unitholders.

But why do they only select between 20 and 30 companies for their call option ETFs? Diversity is a key to any investment strategy, so shouldn’t Harvest ETFs focus on the widest variety of holdings as possible?

In our experience, the focused approach taken in many Harvest ETFs is tied directly to the execution of Harvest’s active and flexible Covered Call Option strategy.

20-30 stocks is not a random number. When we select the stocks we want an ETF to hold, our goal is to create concentrated portfolios, but with large enough capitalization and a wide enough diversity of business styles and operations that we can give investors broadly diversified exposure to a single sector or industry.

We like diversity, and in a one-stop solution for market exposure, having a huge array of companies can make a lot of sense. But for a targeted strategy like a call option ETF, focusing on the leaders of a particular industry or sector means the managers making decisions have a deep familiarity with the companies they hold.

Why familiarity matters in Call Option ETFs?

Call Option trading in an actively managed ETF requires constant engagement with options premiums available on specific stocks. One of the key value adds of an active call option strategy is the flexibility portfolio managers can have, both to generate their consistent monthly distribution and capture higher options premiums when available to expose more of the portfolio to potential market upside.

Unlike some other management teams that apply a one-size-fits-all Call Option strategy, at Harvest ETFs the portfolio manager responsible for an ETF’s composition is also responsible for that ETF’s options trading. The call options strategy fits within the holistic goals of an ETF, executed by a manager who is familiar with that industry’s options market and overall performance. Expanding the number of holdings in a single ETF would require some compromise on the options strategy: meaning managers would use a more systematic and less flexible approach.

Having deep familiarity with a basket of 20-30 stocks means the portfolio managers can understand why the premiums on one stock might be higher than another. This understanding allows managers to be more efficient and effective in delivering the income investors expect from a call option ETF.

The only Harvest equity income ETF with fewer than 20 stocks is the Harvest US Bank Leaders Income ETF (HUBL:TSX), which holds 16 due to a higher degree of concentration in that sector.

A deep knowledge of industry leaders allows Harvest portfolio managers to be opportunistic, capture potential upside, and monetize volatility for unitholders.

Building diversification into active Call Option ETFs

We apply this focused approach to areas of the market where we believe it works. For example, in healthcare. The 20 stocks held by the Harvest Healthcare Leaders Income ETF (HHL:TSX) are 2.5x the entire market capitalization of the TSX. These are huge companies, each with their own diversified lines of business. They have scale and liquidity that’s unmatched in the Canadian market.

When a sector or industry calls for a wider array of holdings, however, that will be built into a Harvest ETF. For example, Harvest’s global utilities and Canadian leaders strategies, which each hold 30 stocks.

Focus is key to maintaining the effectiveness and efficiency of the covered call option writing strategy at Harvest ETFs. However, by efficiently combining an array of strategies into a single ETF, investors can get broad-market diversification while still enjoying income from actively managed strategies. That’s the thesis behind the Harvest Diversified Monthly Income ETF (HDIF:TSX),  which holds six Harvest Call Option ETFs. It pays a high income yield while offering exposure to more than 100 individual companies through its underlying ETFs.

When you have active management of a covered call strategy, familiarity with the sector and the stocks you hold is crucial, At Harvest ETFs, our portfolio managers focus in on the leaders of an industry or a sector to build our individual call option ETFs. By combining them in HDIF, or by giving investors the option to pick and choose from our individual ETFs based on their needs, we can offer broad-market diversification without compromising our call option strategy.

Paul MacDonald is the Chief Investment Officer and Portfolio Manager with Harvest Portfolios Group Inc. 




Commissions, management fees and expenses all may be associated with investing in HARVEST Exchange Traded Funds (managed by Harvest Portfolios Group Inc.) Please read the relevant prospectus before investing. The funds are not guaranteed, their values change frequently and past performance may not be repeated. All comments, opinions and views are of a general nature and should not be considered as advice and/or a recommendation to purchase or sell the mentioned securities or used to engage in personal investment strategies. Tax, investment and all other decisions should be made with guidance from a qualified professional.


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