Growing Balances Amid Wild Market Swings... Retail Investors Flock to Covered Call ETFs [Real Asset Management]

Trading Halts Become Routine Amid Extreme Volatility

Products That Sacrifice Big Stock Rallies for Stable Bonuses

Total Net Assets of Covered Call ETFs Surpass 25 Trillion Won in July

As the stock market continues to experience repeated sharp fluctuations, an increasing number of investors are seeking to turn this very ‘volatility’ into profit opportunities. Covered call exchange-traded funds (ETFs) are at the center of this trend. They can offer monthly cash flow by combining gains from stock investments with option premiums, and they have gained attention for their potential to partially shield investors from losses during market downturns.

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On July 28, the domestic stock market saw both Samsung Electronics and SK hynix, the so-called 'semiconductor giants,' lead a steep decline, triggering not just sell-sidecars but also circuit breakers on both the KOSPI and KOSDAQ exchanges. Last week as well, there were a total of seven sidecar triggers across the two markets, causing alarm bells to sound almost every day out of the five trading days except for one.

In this environment, covered call ETFs have rapidly scaled up. As of July, domestic covered call ETF assets under management have exceeded 25 trillion won, and the number of products, which stood at only six a few years ago, has grown to around 50. The idea is simple: these products become more attractive as volatility increases. The mechanism of covered call ETFs is actually quite straightforward.

Sacrificing Big Stock Gains for Guaranteed Bonuses

The covered call strategy can be easily explained using an apartment transaction analogy. Suppose you purchase an apartment worth 1 billion won, and someone approaches you offering a 50 million won down payment today in exchange for a contract that obligates you to sell the apartment for 1.1 billion won in one year. Accepting this proposal is essentially the covered call strategy.

If the apartment price surges to 1.5 billion won a year later, you still must sell at 1.1 billion won according to the contract, so your final profit is capped at 150 million won (the 100 million won difference in price plus the 50 million won down payment), meaning you earn less than others making a 500 million won gain. Conversely, if prices fluctuate around 1 billion won and do not increase significantly, the other party has no incentive to buy, forfeiting the contract and leaving you with the 50 million won down payment as profit. Even if the apartment price plunges to 700 million won, the upfront payment effectively reduces your actual loss to 250 million won.

The key is that this ‘down payment’—the option premium—becomes more valuable when the market is more volatile. Call options function much like insurance; as uncertainty rises (i.e., volatility increases), so does the associated premium. In fact, the average 20-day Kospi 200 call option premium has recently reached 2.6% of the Kospi 200 index level. While volatility represents risk to investors, for covered call products it is a signal that there will be ample funds for distribution. Amidst the highly turbulent market, the leading domestic covered call ETF (KODEX 200 Target Weekly Covered Call) has recorded a dividend yield in the 10% range over the past year and a total return of over 70% year to date.

Lagging in Bull Markets... but ‘Active’ Management Can Fill the Gap

However, because of their structure, covered call ETFs tend to underperform plain index ETFs in strong bull markets when prices rise far beyond the contract (strike) price. This is essentially the situation illustrated in the apartment example, where one earns less than others during a market surge.

There are products that have partially overcome this structural limitation—‘active’ covered call ETFs. Although the fundamental approach of selling call options is the same, these products allow for flexible changes in the underlying stocks according to market conditions, creating opportunities for excess return (alpha).

For example, the TIGER Semiconductor Top 10 Covered Call Active ETF, launched in April, posted a return in the 50% range by June, outperforming a comparable plain index ETF (TIGER Semiconductor Top 10, with returns in the high 40% range) that uses the same underlying stocks. Lee Sang-hyun, a researcher at Meritz Securities, commented, “By overcoming the structural limits of covered call products through active management, these ETFs have captured both the benefit of monthly distributions from option premiums and excess returns above the index.”

Tax-Free and Tax-Deferred Benefits Make Them Suitable for Retirement Planning

The distributions from domestic equity covered call ETFs consist of (1) dividends from the stocks held, (2) capital gains from trading stocks, and (3) option premium income. Of these, the capital gains and option premium portions are not taxed. A breakdown of one-year distributions for major products shows that only around 4% was subject to taxation. Furthermore, by using an ISA or pension account, investors can reduce or avoid the dividend income tax (15.4%) and the burden of comprehensive financial income tax imposed on regular accounts. This makes covered call ETFs increasingly recognized as both a safe haven from volatility and a tax-efficient investment tool.

However, covered call ETFs are not risk-free products that can completely protect against losses. If the underlying assets plunge, the option premium alone cannot absorb all losses, and with every product calculating its payout ratios and option management differently, it is not easy to compare products just by the numbers alone.

Han Yonghee, a researcher at Growth Research, noted, “Because covered call ETFs pay high distributions monthly, they may appear to be ‘safe, high-yield products,’ but hidden risks still exist. Rather than investing solely in covered call ETFs, a diversified strategy that includes both regular ETFs tracking the same indexes and covered call ETFs is more effective.”

Meanwhile, market volatility in Korea remains high even when viewed on a monthly basis. From July 1 to July 24, including last week, the average daily intraday volatility for the KOSPI was 6.23%. This is the highest monthly figure ever recorded, exceeding even October 2008 (6.11%), at the height of the global financial crisis. The monthly average daily volatility, which was 2.06% in January this year, rose to 2.69% in February, 3.77% in March, briefly slowed in April, then jumped to 4.02% in May, 5.02% in June, and surpassed 6% in July. The KOSPI 200 Volatility Index (VKOSPI) also soared to an intraday high of 97.99 last month before settling at 78.65 on the 24th, which, although lower, is still nearly double the level seen at the beginning of the year, when it was in the 30 to 40 range.

This content was produced with the assistance of AI translation services.