If you've been in the investing world for a while, you've probably heard about -- and dabbled with -- writing covered call options on stocks.When you write a covered call against a stock you own, you sell the right to purchase your shares for a specified strike price at or before a specified future date. You collect a premium -- the price of the option -- for giving up this right. And why? The main reason is to generate some current income. Those returns can be juicy -- 2% to 3% per month or more when things work out just right. My point here isn't to give a full course on covered call writing; there are plenty of resources out there. Instead, here's my issue. Covered call writing on individual stocks can be tricky. Getting good returns means using more volatile stocks, since option premiums are tied to volatility. This is where a lot of investors run into trouble. Moreover, most of us just don't have the time or bandwidth, or don't want to put much risk capital into play this way. That's where covered call funds come in. Covered call writing can be one of those areas where professional help and diversification make a lot of sense. Yet, somewhat to my surprise, only a few funds specialize in covered call strategies, and most toil in relative obscurity to the individual investor. So I want to help show the way. Before going further, here's the main drawing card: Most of these funds pay a steady 8%-10% return, usually as a quarterly dividend. In today's environment of 4.5% money market yields and 5%-6% bond returns, that's not bad. Most covered call funds are so-called closed-end funds, which sell a fixed number of shares that trade on an open market. Click here for the video version of this story from Jennifer Openshaw.
- Index covered call closed-end funds Funds sell covered calls not against stocks but against the S&P 500 index. The result is good income with downside risk matching overall market risk. The S&P 500 Covered Call Fund (BEP) is the largest player.
- Stock covered call closed-end funds These funds sell calls against individual securities owned in the portfolio. These securities can cover the market or target specific sectors, and some blend in international stocks. The portfolio percentage put into play with covered calls may vary as well. These pay somewhat more than index covered call funds. The biggest players include Madison Claymore Covered Call Fund (MCN), First Trust Fiduciary Asset Management Covered Call Fund (FFA) and the ING Global Equity and Premium Opportunity Fund (IGD), which adds an international flavor.
- Open-ended funds As ordinary mutual funds, in the face of competition, seek higher returns, covered call writing is coming back into vogue. Last summer's launch of the (VEPAX) Van Kampen Equity Premium Income Fund (VEPAX) may be one of the purer plays in this space, but the 5.75% upfront load gives me pause.