Unveiling the Risks of Covered-Call ETFs: Why Passive Indices Still Lead

Covered-call ETFs have surged in popularity as investors seek income and downside protection in volatile markets. Yet beneath their allure of high yields and tactical strategies lie structural flaws that often undermine their long-term value. This article examines the hidden risks of these products—underperformance versus passive indices, elevated costs, tax inefficiencies, and concentration risks—and argues for low-cost index funds as a superior core holding alternative.

The Illusion of High Yields

Covered-call ETFs generate income by selling call options on the underlying assets, capping upside potential while collecting premiums. While this strategy can outperform in sideways or declining markets—such as the 2022 bear market—their performance falters in sustained bull markets. Take the Global X S&P 500 Covered Call ETF (XYLD): over a decade, it returned just 6.8% annualized, lagging the S&P 500's 13.6%. Even shorter-term comparisons are stark: the JPMorgan Equity Premium Income ETF (JEPI), with its 11.03% SEC yield, delivered a 7.36% three-year return, still trailing the S&P 500's gains.

Costly Complexity

Active management and derivatives come at a price. The average expense ratio of covered-call ETFs analyzed here is 0.53%, nearly double that of the SPDR S&P 500 ETF (SPY) at 0.09%. For instance, the NEOS S&P 500 High Income ETF (SPYI) charges 0.68%, siphoning returns over time. Compounded over decades, these fees erode gains.

Tax Traps

Many ETFs use equity-linked notes (ELNs), generating ordinary income taxed at higher rates. The JPMorgan Nasdaq Equity Premium Income ETF (JEPQ), for example, faces this issue, whereas the NEOS Nasdaq-100 High Income ETF (QQQI) leverages Section 1256 contracts for a 60/40 long-term/short-term split. Even here, returns-of-capital distributions may mask true performance, deferring—but not eliminating—tax liabilities.

Concentration and Volatility Risks

Active strategies often concentrate bets, amplifying downside risk. The Amplify CWP Growth & Income ETF (QDVO) focuses on tech giants like NVIDIA and Microsoft, leaving investors exposed to sector-specific downturns. Similarly, the Amplify CWP Enhanced Dividend Income ETF (DIVO) holds just 25–30 stocks, creating vulnerability to company-specific issues.

The Case for Passive Funds

Low-cost index funds offer superior risk-adjusted returns. The SPDR S&P 500 ETF (SPY) charges 0.09%, delivers full market upside, and benefits from tax efficiency. Over the past decade, SPY's 93.7% total return handily outperformed covered-call peers. For tax-sensitive investors, Vanguard Total Stock Market ETF (VTI) or iShares Core S&P Total U.S. Market ETF (ITOT) provide broad diversification at minimal cost.

Final Advice: Prioritize Simplicity

While covered-call ETFs have their place in tactical portfolios, their structural flaws—underperformance in bull markets, high fees, tax complications, and concentration risks—make them poor core holdings. Investors chasing yield should instead:

1. Use index funds as the core: Capture market returns with minimal friction.
2. Pair with tax-efficient income sources: Consider dividend aristocrats or Treasury bonds.
3. Reserve derivatives for tactical bets: Use covered calls sparingly in individual positions, not via ETFs.

In a world of complexity, the simplest solution often prevails. Stick with low-cost index funds to build wealth without overpaying for strategies that ultimately underdeliver.

This analysis underscores that covered-call ETFs are a niche tool, not a core investment. For most investors, passive indices remain the bedrock of a resilient portfolio.