Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / How Dividend ETFs Beat Inflation With Covered Calls
Transcript
- Lucas: You know, we talk a lot on this show about dividend stocks as a source of steady income. But there's a whole category of ETFs that have been quietly gobbling up investor dollars this year, and they don't just own dividend payers — they also sell call options on top of them. Luna: Covered call ETFs. I've seen the tickers — JEPI, XYLD, QYLD. The yields are eye-popping, like seven, eight percent. But I've also heard critics say they're just yield traps in disguise. Lucas: That's the debate I want to unpack. Because as of this week, with the 10-year Treasury at 4.57 and the 2-year at 4.16, the yield curve is still pretty flat — 37 basis points spread. Dividend stocks like VYM are yielding around 2.9 percent. SCHD, about 3.4. That's fine, but if you're living off your portfolio, you might want more. Luna: And covered call ETFs promise that 'more.' JEPI's trailing twelve-month yield is over seven percent. XYLD is around six and a half. But what are you actually giving up? Lucas: The main trade-off is upside cap. When you own a covered call ETF, the fund holds a basket of stocks — typically dividend-paying blue chips — and then writes call options on an index, usually the S&P 500. It collects the option premium, which boosts the yield, but if the market rallies hard, the fund's gains are capped because it has to sell at the strike price. Luna: So you're basically trading upside potential for higher current income. That sounds like a reasonable swap if you're retired and need cash flow, not growth. Lucas: Right. And this year, that trade has worked well. The S&P 500 is up modestly — about 8 percent year to date — but it's been choppy. Covered call funds capture most of the dividend income plus the premium, and they've outperformed plain dividend ETFs in terms of total return. JEPI is up about 6 percent this year versus VYM's 4. Luna: But what about taxes? Option premiums are taxed as short-term capital gains, not qualified dividends. For someone in a high tax bracket, that extra yield gets eaten up pretty quickly. Lucas: That's a critical point. If you hold these in a taxable account, the income is less efficient than qualified dividends from something like SCHD. But in an IRA or 401k, that doesn't matter. So it really depends on where you hold them. Luna: I've also seen a lot of new entrants this year — firms like Global X, Nuveen, even First Trust launching covered call variants on specific sectors. Is that a sign the strategy is getting crowded? Lucas: It's definitely a hot space. According to Morningstar, inflows into option-income ETFs hit $12 billion in the first half of 2026. That's more than double the pace from last year. But 'crowded' doesn't necessarily mean it's about to blow up. The strategy itself is pretty mechanical — the options are written on broad indexes, so liquidity is fine. Luna: Still, if we see a sharp market downturn, these funds could take a hit on the stock side and the option premiums might not be enough to cushion the fall. In 2022, JEPI fell about 12 percent, which was less than the S&P's 19 percent drop. So they do provide some downside buffer. Lucas: Exactly. The premium income acts as a shock absorber. But in a prolonged bear market, that buffer might not be enough. Let's look at the numbers: JEPI's expense ratio is 0.35 percent — reasonable. XYLD is 0.60, a bit higher. Compare that to VYM at 0.06 or SCHD at 0.06. You're paying for the active option overlay. Luna: So when would you recommend a listener use these? Is it a core holding or a satellite position? Lucas: I'd say satellite. If you need yield to cover living expenses and you're comfortable capping your upside, allocate maybe 10 to 20 percent of your income portfolio to a fund like JEPI. Then keep your core in low-cost dividend growth ETFs. The combination gives you baseline growth plus extra cash flow. Luna: That makes sense. And you can also layer in a fund like DIVO, which does covered calls but on individual stocks, not the index. It yields around 4.5 percent but has more upside potential because the calls are written on a concentrated portfolio. Lucas: Right. DIVO is an interesting hybrid — it holds about 20 stocks and writes calls on about half of them. So you get more equity exposure. But it's also more active management, so the expense ratio is 0.55 percent. Luna: Before we wrap, I want to touch on one more thing: the dividend growth angle. A listener might worry that by buying a covered call ETF, they're giving up the dividend growth that comes with owning individual stocks or traditional dividend ETFs. Lucas: That's true. JEPI's dividend income fluctuates because the option premiums vary each month. In months with high volatility, premiums are bigger and the payout is higher. In calm months, it's lower. So you don't get the predictable, growing dividend stream that a company like Coca-Cola or Procter & Gamble provides. Luna: So for someone who values consistency — like retirees who want to know exactly what their next check will be — covered call ETFs might add unwanted uncertainty. Lucas: Exactly. And that's why it's not an either/or. You can own Coca-Cola for its reliable 3.2 percent yield and growing dividend, and then add a small slice of JEPI for extra income. The key is knowing what each piece is doing for you. Luna: Speaking of knowing what pieces are doing — if our money conversations have helped you think about a decision differently, a couple of dollars a month is genuinely what keeps these going. Buy me a coffee dot com slash fexingo, if you've gotten something out of them. Lucas: Yeah, it's a small way to keep the show ad-free and focused on the substance. We appreciate it. Luna: Alright, so to bring it back — if you're looking at covered call ETFs, what's one key metric to watch? I'd say look at the premium to expense ratio. Make sure the option income isn't being eaten up by fees. Lucas: And also compare the fund's total return, not just yield. A fund that yields 8 percent but loses 5 percent in NAV over a year is giving you a net 3 percent. That's not necessarily better than a dividend ETF yielding 3 percent with stable NAV. Luna: Good point. I think for most investors, the best approach is to keep it simple: low-cost dividend growth ETFs for the core, and then a satellite of covered call ETFs if you need extra income and understand the trade-offs. Lucas: And as always, check your own time horizon and tax situation. Covered call ETFs aren't for everyone, but in a flat yield curve environment like we have now, they're worth a close look.