Dissecting the Structure of Covered Call ETFs
A 10% Call-Selling Ratio and a 10% “Premium”
Pros and Cons Depend on Market Conditions
Covered call exchange-traded funds (ETFs) are growing rapidly in Korea. At the end of 2023, there were 11 such ETFs with combined net assets of KRW 776.4 billion. By September 2024, an additional 13 products had been listed, pushing total assets to approximately KRW 4.8 trillion. This rapid growth has also raised concerns among financial regulators. In particular, the use of numerical expressions such as “+10% premium” as target figures may be misleading to investors.
In options terminology, premium refers simply to the price of an option. However, the word can also carry connotations of superiority or exclusivity, and presenting a numerical “target premium” may lead investors to mistakenly interpret it as a guaranteed return. For this reason, Korea’s Financial Supervisory Service (FSS) has tightened disclosure requirements, prohibiting the use of numerically stated target distribution rates and the term “premium” in securities registration statements and prospectuses. Instead, issuers are now required to explain the payoff structure in terms of option maturity, strike price, and the ratio of options sold relative to the underlying asset—also known as the coverage ratio.
An option is a contract that grants the right to buy or sell a specific underlying asset at a predetermined price (the strike price) on a future date (the maturity). A call option gives the right to buy, while a put option gives the right to sell. In Korea, only ETFs employing covered call strategies—selling call options while holding the underlying asset—are currently listed.
Option maturities can be monthly or weekly. Until recently, weekly options expired only on Fridays, but they are now listed for every weekday from Monday through Friday. This has enabled daily call-selling strategies. Statistically, the combined premiums from shorter-dated options tend to exceed those from longer-dated options over the same time horizon. As a result, selling a smaller proportion of options can still generate the targeted level of distributions. This is why many recently listed ETFs adopt weekly or daily option-selling strategies.
The strike price is the price at which the underlying asset can be bought or sold at maturity. When the strike price equals the current price of the underlying asset at the time of sale, the option is called at the money (ATM). When the strike price is higher than the current price, it is referred to as out of the money (OTM). In covered call strategies, selling ATM options means fully giving up upside participation in exchange for higher option premiums. With OTM options, the degree of upside participation depends on how far above the current price the strike is set. For example, selling a +5% OTM call allows participation in price gains of up to 5% until maturity. OTM strategies sacrifice some premium income relative to ATM options but retain partial upside exposure.
The option-selling ratio—also known as the coverage ratio—refers to the proportion of call options sold relative to the underlying asset. In the market, covered call ETFs broadly fall into two categories: those with a fixed coverage ratio and those that target a stated distribution level.
ETFs with a fixed coverage ratio include TIGER U.S. 30-Year Treasury Premium Active (H) and the RISE Daily Covered Call series, which is expected to be listed around September or October. The TIGER ETF purchases long-term U.S. Treasuries and sells weekly call options covering up to 30% of the underlying exposure. The RISE series buys U.S. dividend and technology portfolios and sells related call options daily at a fixed coverage ratio of 10%. For ETFs with fixed selling ratios, the portion not covered by options—calculated as (1 minus the coverage ratio)—remains fully exposed to upside movements in the underlying asset.
By contrast, ETFs marketed with target distribution figures such as “+10%” or “+15%” adjust the option-selling ratio to achieve the stated premium level. For instance, if achieving a +15% target requires selling options on 40% of the underlying asset, a +10% target might be achieved by selling options on only 30%. Even with the same target distribution, choosing ATM over OTM options, or daily over monthly option-selling strategies, can reduce the required coverage ratio and increase upside participation.
The preliminary prospectus for the RISE Daily Covered Call series—expected to be the first listing following the FSS’s enhanced disclosure rules—provides detailed explanations of the underlying assets, option types, selling methods, and strike prices.
Covered call strategies are best suited to markets where the underlying asset exhibits moderate volatility and a gradual upward trend. If asset prices decline, covered call ETF prices also fall, but the option premiums received help cushion the downside. The most challenging environment is one characterized by sharp rallies and steep declines: upside participation is capped, while downside protection is limited to the premium collected. That said, covered call ETFs are evolving, incorporating increasingly sophisticated option strategies to mitigate these weaknesses. Within the asset management industry, the FSS’s enhanced disclosure requirements are widely viewed as part of the growing pains of a maturing product category.
Ultimately, the key is for investors to carefully review the prospectus—available through the FSS’s electronic disclosure system or on asset managers’ websites—before investing, and to select products aligned with their investment objectives. Covered call ETFs are currently the only structured products listed in Korea outside of equities and bonds. Rather than avoiding them due to perceived complexity, investors who understand and appropriately utilize these evolving instruments may gain an additional and valuable tool for portfolio management.