BMO Global Asset Management is planning to launch three new ETFs on the London Stock Exchange – the BMO Enhanced Income UK UCITS ETF (ZWUK), BMO Enhanced Income EU UCITS ETF (ZWEU) and BMO Enhanced Income US (ZWUS). The new ETFs use a covered call strategy to boost the income of their benchmark equity indices, the FTSE 100, the Euro Stoxx 50 and the S&P 500.

Chris McHaney, vice president & portfolio manager, BMO Global Asset Management

A covered call is an options strategy whereby an investor holds a long position in an asset and sells or “writes” call options on that same asset in an attempt to generate more income (the additional income from option premium) than the asset would otherwise provide on its own from dividends or other distributions.

Historically, during bear markets, range-bound markets and modest bull markets, this type of covered call strategy has generally outperformed its underlying securities. However, during strong bull markets, when the underlying securities may frequently rise through their strike prices, covered call strategies historically have tended to lag.

Chris McHaney, vice president & portfolio manager, BMO Global Asset Management, commented: “The funds will target 2-4% in option premium income and the strategy dynamically adjusts the strike price of options depending on market conditions. In more volatile markets, call options with strike prices that are further out-of-the-money will be sold, and in less volatile markets, options with strike prices that are closer to the money will be utilised.

“An option premium yield above 4% tends to result in unfavourable upside capture, as aggressive option strike prices have the potential to limit upside in strong market growth; less than 2% yield and the strategy loses its appeal as it becomes closer to beta in nature.”

The ETFs will provide full physical replication of their respective underlying benchmarks. The amount of the portfolio covered by options will be dependent on market conditions: the funds will target a 50% coverage ratio with coverage moving lower in volatile markets and slightly higher in periods of low volatility.

McHaney added: “By using an options overlay that adds meaningful income while mitigating the opportunity cost of the strategy, the new ETFs offer the potential to achieve benchmark returns over the long term, with reduced volatility and higher current income.”

The ETFs will have total expense ratios of 0.30%.