For over 50 years, options have been proving their utility as risk management and income generation tools and with the advent of active ETFs, accessing these strategies has never been easier.

Seeking to avoid the interest rate, credit, and prepayment risks that have recently plagued fixed income, investors are increasingly turning to option-based funds to generate income with popular “covered call” ETFs gathering $25 billion in new assets in 2023 alone (chart) and dozens of other funds now selling options on everything from stock indexes to individual stocks to commodities and even bonds (table).

*Selected option income ETFs as of Jan 2024. Source: ETF.com, Yahoo Finance. Click for larger image.*

Instead of complex bond variables, yields in option writing funds are mainly a function of market volatility. All else equal, the more volatile an option-writing fund’s underlying asset, the more premium in its options and the higher the fund’s expected yield- sometimes even stretching into triple digits for funds selling options on highly volatile names like the Yieldmax COIN Option Income Strategy (CONY).

Of course, every investment involves tradeoffs. Since they must hold an underlying asset as collateral to enable the sale of options, option income funds assume the downside risk of that asset in order to generate upside that is limited mainly to the premium received from each option sale. While the accumulation of this premium generally tracks the underlying asset’s trend over time, equity option income funds are not expected to precisely track the stock market. Rather, they are intended as vehicles for producing monthly income.

To harness the power of options income, the TCM Hedged Yield strategy builds a portfolio of option income ETFs across an array of approaches and underlying assets. Though the strategy is not benchmarked to equities, its stock market foundation lends itself well to the use of TCM’s tactical VIX overlay to manage equity crisis risk.

Despite its equity correlation, the strategy’s main focus is on monthly income. With a current net annual distribution yield near 13%, even relatively small allocations to Hedged Yield are capable of producing a substantial income stream that is insensitive to changes in interest rates and that should persist for as long as the options market does. At a client’s discretion, the strategy’s monthly dividends can also be reinvested in order to further enhance the portfolio’s future income, making Hedged Yield a natural fit for retirement planning.

As planners are aware, an early start to the dividend reinvestment process means a lower initial investment to reach a given income target in retirement (see chart below), making Hedged Yield most attractive for tax advantaged accounts with a sufficient time horizon. Like options themselves, this exciting new innovation is changing the investment landscape and we invite you to schedule a webinar today to learn more.