The Amplify CWP Enhanced Dividend Income ETF(NYSEMKT: DIVO) is not your normal exchange-traded fund (ETF). And that's exactly why you might want to buy it, particularly if you are at a point in your life where you want to generate some extra income from your portfolio. Here's a quick look at the somewhat unique covered-call-writing ETF with a generous 4.6% yield.
What are covered calls?
There are different ways to generate income from your savings. The most basic is to simply collect interest on cash you have saved in a bank account, CD, or money market fund. Stepping deeper into investing, you can collect interest payments on bonds or dividends from stocks you own. But there are some more complicated choices, too, like selling covered call options on stocks you own.
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A covered call gives someone else the right to buy your stock at a set price at some point in the future. In exchange for giving someone that right you get an upfront payment. You get to keep that payment even if the person never exercises their right to buy the stock. If they do exercise their option to buy you have to sell at the agreed-upon price. Although this is a fairly simple type of option, there are still a lot of moving parts involved. Covered calls aren't something that a new investor should try. And they aren't something that you'll want to get involved in unless you intend to pay fairly close attention to your portfolio all the time (an option can get exercised at any point in time up to the date it expires).
Still, the benefit of selling options can be material. Essentially, you are potentially creating income from a portfolio that wouldn't exist in any other way. And if the options you sell don't get exercised, you get to keep the stock, potentially allowing you to sell more options in the future. A lot of investors enhance their income streams with a covered call strategy. And, as you might expect, asset managers are aware of the potential and sell exchange-traded funds that allow small investors to get involved with covered calls without having to put in all of the work of managing their own covered call portfolios.
The Amplify CWP Enhanced Dividend Income ETF is different
Most ETFs are passive investments that track indexes. That model exists in the covered call space, as well. But most investors wouldn't take an index approach to covered calls in their own portfolio. They would actively manage a list of stocks they like and opportunistically sell covered calls on those stocks. That is, basically, what the Amplify CWP Enhanced Dividend Income ETF does.
For starters, the ETF is actively managed. So there are human beings selecting stocks for the portfolio. The list is highly curated, with just 30 or so holdings at any given time. The goal is to own high-quality dividend stocks, with top holdings in the portfolio including UnitedHealth, Home Depot, Amgen, Caterpillar, and Visa.
UNH Dividend Yield data by YCharts
Visa is probably the most interesting name on that list because its dividend yield is less than 1% and, in fact, about half the level, or less, of all of the other top stocks. But dividend growth over time has been impressive and so has Visa's stock performance. It is a growth and income/dividend growth investment, for sure, but not a stock that would normally interest an income-focused investor. However, selling covered calls on the stock could up its attractiveness from an income investor's point of view. This is what the Amplify CWP Enhanced Dividend Income ETF does, but on a tactical basis, picking and choosing the best covered call options to write, and when, across its entire stock portfolio. It does not write covered calls in bulk fashion, however, and may only have a few covered transactions outstanding at any given time.
In fairness, the Amplify CWP Enhanced Dividend Income ETF isn't going to be the best-performing ETF you can buy. Selling covered calls often limits upside potential because the biggest winners will get called away (meaning they have to be sold). As the chart below shows, the ETF's total return has lagged that of an S&P 500 Index ETF. But the goal isn't really trying to achieve the highest total return, its goal is to produce a healthy stream of income without taking on undue risks. The ETF's yield is an attractive 4.6%, which is much higher than the 1.3% or so for the S&P 500 today. If there's some modest portfolio growth along with that income, that's icing on the cake. The Amplify CWP Enhanced Dividend Income ETF has easily lived up to that income and growth expectation so far. And with a fairly reasonable expense ratio of 0.56%.
Of course, the ETF probably shouldn't be your only investment. It is best viewed as a way to add a unique income-producing asset to a more broadly diversified portfolio. And to do that in a way that would likely be similar to the way you would do it if you wanted to put in the time and effort.
The Amplify CWP Enhanced Dividend Income ETF could be a nice addition
If you have looked at covered calls, or even dabbled in the practice, but decided that it's just too much work, then the Amplify CWP Enhanced Dividend Income ETF could be the type of investment you have been looking for. Buying good companies and selling covered calls on them is, likely, what you would do if you wanted to put in the effort. This ETF lets you get the income benefit of covered calls without the effort, allowing you to spend your free time in more attractive ways.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Home Depot and Visa. The Motley Fool recommends Amgen and UnitedHealth Group. The Motley Fool has a disclosure policy.
