Why XYLD's Covered Call Strategy Falls Short in a Rising Market

The eternal tension between income generation and capital growth has never been more pronounced in modern investing than in the case of high-yield exchange-traded funds (ETFs). Among these, the Global X S&P 500 Covered Call ETF (XYLD) has long been a favored tool for income-seeking investors, leveraging a strategy that systematically sells call options on its underlying S&P 500 holdings to generate premiums. Yet, as recent market dynamics underscore, this approach carries a critical limitation: it sacrifices upside potential during periods of strong equity market performance. In a rising market, XYLD's strategy not only underperforms growth-focused ETFs but also highlights the inherent trade-offs between yield and appreciation.

The Mechanics of Covered Call Strategies

XYLD's methodology is straightforward. By selling call options, the fund collects premiums from investors who bet on further stock price increases. This generates a steady income stream, often yielding 7–12% annually, as noted in 2025 market analyses. However, this strategy caps gains when the underlying stocks rise above the strike price of the sold options, at which point the shares are "called away" to the option buyer. In contrast, growth-oriented ETFs like the SPDR S&P 500 ETF Trust (SPY) or sector-specific funds focused on technology and consumer discretionary stocks allow investors to fully participate in market rallies without such constraints according to 2025 market trends.

Historical Performance in Bull Markets

The one-year period ending March 18, 2024, provides a stark illustration of this dynamic. During this time, SPY surged by 33%, reflecting the broad-based strength of the S&P 500 and its growth components. Meanwhile, XYLD managed only a 12% gain, significantly trailing its benchmark according to Nasdaq reporting. This underperformance is not an anomaly but a structural feature of covered call strategies. As a report by CheddarFlow explains, such ETFs "outperform in sideways or moderately bullish markets but lag in strong upswings due to the capped upside" as detailed in their guide. The same logic applies to other covered call ETFs, though some, like the NEOS S&P 500 High Income ETF (SPYI), employ more active and data-driven option strategies to mitigate this drag, achieving a 22% return in the same period.

The Cost of Yield: Expense Ratios and Opportunity Costs

Beyond structural limitations, covered call ETFs like XYLD face another headwind: higher expense ratios. These funds typically charge between 0.35% and 0.68% in annual fees, compared to the 0.09% expense ratio of SPY. While the additional costs are partially offset by premium income, they erode returns in environments where growth ETFs are compounding at a faster rate. For instance, in a market rising by 30%, the opportunity cost of forgoing full participation-due to both capped gains and higher fees-can outweigh the benefits of yield.

Market Conditions and Strategic Trade-Offs

The relative merits of covered call and growth ETFs also depend on broader market conditions. In 2025, macroeconomic uncertainty has led to a bifurcated landscape. Growth ETFs, particularly those weighted toward technology and consumer discretionary sectors, have shown modest gains but remain volatile according to 2025 market trends. Covered call ETFs, meanwhile, offer a degree of downside protection through premium income, though they do not shield investors from major downturns as CheddarFlow notes. This duality forces investors to confront a fundamental question: Is the trade-off between income and growth aligned with their risk tolerance and time horizon?

Conclusion: Aligning Strategy with Objectives

XYLD's underperformance in rising markets is not a flaw but a feature of its design. For investors prioritizing income over capital appreciation, the fund remains a compelling option, particularly in environments where equity markets stagnate or decline modestly. However, in periods of strong growth, the strategy's constraints become a liability. As Schwab's investor guide notes, "covered call ETFs are best suited for those who prioritize regular income and moderate downside protection over aggressive capital gains." In a world where market cycles are increasingly unpredictable, the key lies in aligning one's portfolio with the right balance of these competing priorities.