How to reduce risk with a conservative covered call approach on 3 strong dividend-paying ETFs on buy

How to reduce risk with a conservative covered call approach on 3 strong dividend-paying ETFs on buy

Selling covered calls on conservative dividend-paying ETFs can reduce risk but still provide real returns for astute investors and traders.



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The recent decline in 10-year Treasury yields, well below the 4% level, has made dividend-paying stocks relatively more attractive once again. The fact that the Fed is closer to the end than the start of recent rate hikes makes higher yielding stocks a solid choice in the coming months.

Rather than trying to pick individual stocks, buying a higher yielding ETF can be a safer and more sensible approach. Here are three A-rated Strong Buy – Dividend funds to consider buying along with a covered call to consider selling.

  • Vanguard High Dividend Yield (VYM) ETFs
  • SPDR Dividend ETF (SDY)
  • iShares Select Dividend ETFs (DVY)

These three ETFs all have lower market risk (less than 1.00 beta) and lower market valuations on both a price to earnings basis (P/E) and price to sales (P/S). They also each have a higher dividend yield than the S&P 500. So overall, a safer pick than the broader market. Below is a quick comparison of the three dividend ETFs against the S&P 500.

Additionally, selling a covered call against the dividend ETF can further reduce risk and generate potentially higher returns.

Each of the three highest yielding ETFs has different components that make up the overall basket of stocks. Notice how oil giant Exxon Mobil (XOM) is a major part of all three ETFS, but has a slightly different weighting and ranking within each fund.

Let’s take a short walk through the three.

VYM (Vanguard High Dividend Yield ETF)

VYM has a price to earnings (P/E) ratio of just over 14 (14.09) and a price to sales (P/S) ratio just north of 2 (2.06). Both are at a discount to similar metrics for the S&P 500 of 18.43 for P/E and 2.96 (P/S). The beta for the VYM is 0.85, thus a lower risk than the overall market. It has a yield of 3.02%, well above the S&P 500’s yield of just 1.64%. It ranks third in the Large Cap Value ETF category.

The top 10 holdings in VYM account for more than 23% of total assets. JP Morgan (JPM) and Johnson and Johnson (JNJ) occupy the top two spots.

Selling the $116 July call versus buying VYM’s underlying can reduce the net cost by about $5.00 (over 4%) while still leaving about 3% upside appreciation open to the $116 short strike. 116. You also still get a dividend above 3% as long as VYM stays below $116.

SDY (SPDR S&P Dividend ETF)

Check in at number 6 in Large Cap Value ETFs.

The 10 largest holdings in SDY make up just over 20% of the overall ETF. ExxonMobil (XOM) and AT&T (T) are the top two.

Selling the $137 July call versus buying SDY’s underlying can reduce the net cost by about $5.00 (just under 4%) while still leaving more than 4% upside appreciation open to the $137 short strike. 137. You also still get a dividend above 2.5% as long as SDY stays below $137.

DVY (iShares Select Dividend ETF)

DVY ranks eighth in the Large Cap Value ETF category.

Below are the top 10 holdings for DVY. They are just under 20% of total assets. Valero (VLO) and Altria (MO) get the highest weights.

Selling the $130 June call versus buying DVY’s underlying can reduce the net cost by about $4.20 (well over 3%) while still leaving about 4% upside open to the short strike of $130. You also still get a dividend above 3.3% as long as DVY stays below $130.

After the recent hot run in stocks, many traders and investors are looking to reduce risk and still maintain returns. Taking a more conservative approach to covered calls on high-yielding, lower-beta quality ETFs is certainly a solid way to play healthier.

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I wish you the best!

Tim Biggam

Editor, POWR Options Newsletter


SPY shares closed $402.33 on Friday, down $-0.09 or -0.02%. Since the beginning of the year, SPY is down -14.31%, compared to a % increase in the benchmark S&P 500 index during the same period.


About the author: Tim Biggam

Tim spent 13 years as a Chief Options Strategist at Man Securities in Chicago, 4 years as a Lead Options Strategist at ThinkorSwim and 3 years as a Market Maker for First Options in Chicago. He appears regularly on Bloomberg TV and is a weekly contributor to the TD Ameritrade Network’s “Morning Trade Live”. His main passion is to make the complex world of options more understandable and therefore more useful for the everyday trader. Tim is the editor of the POWR Options newsletter. Find out more about Tim’s background, along with links to his most recent articles.

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