Leverage Shares to launch single-stock covered call ETPs in Europe

Leverage Shares is on Tuesday due to launch Europe’s first “covered call” exchange traded products based on single stocks.

The initial batch of three ETPs will be centred on technology stocks Nvidia and Tesla, as well as the SPDR Gold Shares ETF (GLD), which tracks the price of the metal.

Covered call ETFs involve selling call options on the underlying index or stock. This limits an investor’s potential upside capital gain but provides a stream of premium income instead — augmenting a limited capital gain or, in the worst-case scenario, cushioning losses if the price of the underlying asset falls.

The concept has taken off in the US in the past two years, with assets jumping from $16.6bn at the start of 2022 to $77.1bn now, according to figures from Morningstar Direct. JPMorgan’s wildly popular Equity Premium Income ETF (JEPI) has alone raked in $33.9bn.

However, covered call ETFs based on single stocks, rather than broad indices, are only a small part of this universe. US market leader YieldMax has $3.2bn across its range of option income strategy ETFs, while newcomer Kurv has also entered the market and Purpose Investments offers similar funds in Canada.

Covered calls have yet to seize the imagination of European investors to the same extent, though, with the JPMorgan Global Equity Premium Income ETF (JEPG), the US group’s Ireland-domiciled riff on JEPI, currently holding just $154mn. Global X also offers Europe-listed covered call ETFs based on the S&P 500 and Nasdaq 100 with combined assets of $205mn.

Nevertheless, Jose Poncela, head of product at Leverage Shares, which recently passed $1bn in assets under management, believed there was a viable gap for such products in the European market.

“There is nothing like this in Europe,” he said. “We are hoping to provide some really good yield and provide something unique.”

Part of the rationale for single-stock, rather than index-based, covered calls, is that individual securities tend to be more volatile. This heightened volatility means a call option written by an ETF or ETP is more likely to be called. This in turn renders it more valuable, meaning it can typically to sold at a higher price, generating greater monthly premium income.

On the downside, as investors remain fully exposed to the underlying asset, greater volatility increases the risk of a significant capital loss.

Leverage Shares’ ETFs will sell “slightly” out-of-the-money call options, meaning the option’s strike price is above the market price. While this reduces the premium income, it does leave scope for some modest capital gains.

“We are milking some yield out of the volatility [while retaining] some exposure to the stocks,” said Oktay Kavrak, product strategist, of the Nvidia and Tesla ETPs. “It’s for income-oriented investors. Tesla is not a dividend paying stock.”

As for the GLD-based fund, Poncela said: “We want to retain the investment case for gold. Gold has had this bad reputation: it doesn’t do much. It sits in your portfolio. Yes, it diversifies. We try and get around that by offering a yield on gold, and a yield that is greater than the Fed funds rate.”

Poncela said Leverage Shares has plans to launch at least 10 similar ETPs, which will be labelled under a new IncomeShares sub-brand to differentiate the funds from its existing leveraged and inverse ETP range that account for the bulk of its current roster.

It is also planning to launch a range of index-based derivative income ETPs in August. However, these will sell zero-day-to-expiry put options, which give the buyer the right to sell an asset at a preset price, as opposed to the right to buy enshrined in a call option.

Kenneth Lamont, senior fund analyst for passive strategies at Morningstar, said that “options, if used sensibly, can be a force for good”, and accepted that covered call ETFs had proved popular in the US, but questioned who they were aimed at.

“What is the audience for these products? If you can understand options you can probably go and do it yourself, and if you don’t you probably shouldn’t be buying these products,” Lamont argued.

“These are basic options strategies. You or I could open an account and go and buy and sell options to cover our own calls. It’s not that complicated,”

As for Tesla and Nvidia, Lamont argued they were “inherently risky” and most investors should not hold such stocks other than as part of a “properly diversified portfolio”.

Garrett DeSimone, head of quantitative research at OptionMetrics, a provider of options data, said that in the US covered call ETFs are “targeted at retail investors”, who could go down the do-it-yourself route, but that that “requires some expertise”,

“It’s a strategy with an upside cap, so these strategies tend to underperform in a big way during bull rallies, and you have to deal with the drag of the fees. It’s really a short volatility position,” DeSimone added.

However, he said that funds that write out-of-the-money call options, as Leverage Shares intends to do, are generally “more profitable” than those that write at-the-money options.

“When you put your calls closer to at-the-money you get called more frequently. Out-of-the-money you get more upside. You are sacrificing some yield [but], from research, at-the-money do not perform as well relative to out-of-the-money.”

The Leverage Shares’ ETPs will be priced at 55 basis points for the single-stock funds and 35bp for the one based on GLD. They will be listed on the London stock exchange in dollars and sterling, with cross-listings on other European bourses likely to follow.