Amid the turmoil of rising interest rates, persistent inflation and ongoing geopolitical uncertainty, equity markets have fallen substantially. That sell-off, which began in early 2022, has been especially painful for retirees and those still building retirement savings.
Even fixed-income instruments, traditionally seen as a safer alternative, lost value as interest rates rose—reflecting the inverse relationship between interest rates and bond prices.
In this environment, investors focused on retirement income may want to consider strategies that generate additional cash flow. One such approach is covered call writing. Before outlining that strategy, it helps to understand the underlying instrument: the call option.
What is a call option?
A call option is a contract that gives the buyer the right, but not the obligation, to purchase a specific stock at a predetermined price (the “strike price”) before the option expires. The buyer pays the seller a fee, known as a premium, for this right. The seller keeps the premium whether or not the buyer exercises the option.
An option is considered “covered” when the seller already owns the underlying shares, meaning they can deliver the stock if the option is exercised. If the seller does not own the shares, the option is “naked,” which carries greater risk.
How a call option works
Imagine you buy a call option that allows you to buy one share at $50 anytime within the next 30 days. You pay the seller a $2 premium to lock in that price.
If the share rises to $55 during the option period, you can exercise the option and buy at $50. Your effective cost is $52 (strike price plus premium) for a security worth $55, giving you a $3 profit per share before fees and taxes. If the share falls to $45, you can let the option expire and your loss is limited to the $2 premium.
Call options offer several potential benefits for investors, including:
- Income generation: Selling call options produces premiums that can increase cash flow. When packaged within an ETF, this strategy can deliver regular distributions to unitholders regardless of short-term price moves.
- Downside mitigation: Premiums received from writing options provide a cushion against declines in the underlying holdings, reducing portfolio volatility. Higher implied volatility generally increases option premiums, which can benefit option sellers.
- Tax efficiency: In many jurisdictions, income from covered call premiums may receive favorable tax treatment compared with interest or ordinary dividends. In some cases, premium income is treated as a capital gain rather than ordinary income, which can lower the investor’s tax burden.
Call options and retirement investing
For retirement portfolios, call options can serve dual purposes: enhancing income and offering some protection during volatile markets. This can be attractive to investors who prioritize steady, reliable cash flow alongside capital preservation.
Instead of trading options directly, many investors opt for professionally managed exchange-traded funds (ETFs) that employ covered call strategies. These ETFs sell call options on a portion of their holdings to generate premiums, then distribute that income to investors as regular payouts. This approach provides an easier, hands-off way to gain exposure to covered call strategies while benefiting from professional portfolio management.
What is covered call writing?
Covered call writing is a tactic in which an investor sells call options on stocks they own to collect premiums. When implemented inside an ETF, the fund writes calls against some of its equity positions and uses the premiums to support regular distributions. These funds—often described as covered call ETFs or equity-income ETFs—are designed to deliver higher monthly cash flow and more tax-efficient income for retirement portfolios.
Using covered calls does mean accepting some trade-off: if the market rises sharply, the ETF may have to sell appreciated shares at the strike price, thereby missing out on some upside. To manage that trade-off, some managers cap option writing at a portion of the portfolio—for example, limiting written options to a maximum of 33% of holdings—and use active management to keep as much capital exposed to market growth as possible.
Harvest ETFs is one provider that offers covered call ETFs. Its managers combine stock ownership with selective option writing to generate tax-advantaged income and monthly distributions while seeking risk-adjusted returns. By using an active and flexible approach to writing options, these funds aim to balance steady income with participation in market gains.
While reliable cash flow is a key goal for retirement planning, investors should remember that covered call ETFs are not risk-free. They can reduce volatility and boost income, but they may limit upside in strong rallies and still carry market risk. It’s wise to research these products carefully and consult a financial professional to determine whether they suit your retirement plan.
Read more about retirement planning:
- We’re living longer—here are two ways to boost retirement savings and income
- What does high inflation mean for your retirement savings?
- What do rising interest rates mean for retirement savings?
- A strategy for non-registered and TFSA accounts in retirement
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