Capital Wealth Planning Interview

Some investors prefer to use exchange traded funds (ETFs) for their covered call writing. We spoke to a professional money manager who does just that. We asked him about his low volatility strategy and here's what he had to say.

Capital Wealth Planning

BTS (Born To Sell): Kevin Simpson is the Chief Investment Officer and founder of Capital Wealth Planning a private wealth management company based in Naples, Florida. Kevin, can you tell us a bit about you and your company?

KS (Kevin Simpson): Sure. I've been trading covered calls as an investment professional for over 20 years. I'm a big believer that everyone who owns stocks should be selling calls against those positions to generate income. To that end we started Capital Wealth Planning in 2005 to offer separately managed accounts with two main services: First, our flagship product, is an ETF-based covered-call strategy. Second, we help people who have large concentrated stock positions generate additional income by selling call options against them. Today we have over $300 million in assets under management.

BTS: I understand your fund is comprised only of ETFs?

KS: It's not a fund per se. We create a model portfolio and then manage separate accounts so that everyone gets the same pro-rata share of each holding in their own account. Each client has 100% transparency as to what they hold because the account is in their name at their broker; they can look up at any time what we've bought for them or what options we've sold in their accounts.

But to answer your question, yes, we only deal in ETFs. We like the lower volatility of index-based ETFs compared to individual stocks. Our goal is low risk, high income.

BTS: How many ETFs do you hold at one time?

KS: Usually 10-12. We never buy leveraged ETFs. We sometimes buy the inverse market (S&P) ETF and then write calls against it, too, to lower volatility even more. Our general goal is not to outperform a bull market but to make money consistently with lower volatility. We aim to capture 65% of the market's upside while limiting downside to 35%.

ETF covered calls

BTS: I assume your clients are fairly risk averse?

KS: Yes. This is a conservative, enhanced income strategy.

BTS: What kind of ETFs do you hold?

KS: It varies but we use a risk matrix with a goal of having about half the standard deviation of the S&P 500. We have large cap ETFs, fixed income ETFs, non-leveraged inverse ETFs, as well as 20-30% in sector exposure (such as financials, healthcare and technology). The sectors rotate frequently. We also have a small 5% to 7% exposure to international markets.

BTS: What kind returns do you target?

KS: We aim for at least 2% dividend yield, and then another 3% to 3.5% in option premium. So we have over 5% income yield. Any additional gain (or loss) is up to the market.

BTS: What do you do if one of your ETFs drops below your adjusted cost basis?

KS: We typically write options that are short term, so we're always making adjustments. If something has gone down we ignore our basis and ask ourselves a couple of questions: (1) Do we still like the fundamentals and technicals of the ETF? If not, sell and take the loss. (2) If we're keeping it, how can we extract the most income possible during the next cycle and still leave some room for upside? If that means selling a call below our cost then we'll do that.

We view it as a clean slate each month. We don't have the "must get back to even" or "never get exercised below cost" mentality.

BTS: What about taxes?

KS: We ignore tax issues and focus on how to generate the best return. At the end of the year we can do some tax optimization since we have laddered positions and we own inverse ETFs as well as regular ETFs. We can almost always realize a gain or loss if needed for tax reasons. Keep in mind that some of our clients have tax-deferred accounts so it's a non-issue for them anyway.

BTS: Ever sell in the money options?

KS: No. Because we're looking to get 65% of any upside in the market, we sell out of the money options. Usually short term, 1-2 months. Sometimes weeklys. Maybe 5% or more out of the money. Remember, our annual goal from call premium is only 3.5%/year, or around 0.2% per month. We like to leave ourselves room for upside potential in the underlying ETF.

BTS: What about naked puts or use of margin?

KS: We don't use any margin. I like naked puts as a way to enter a position and protective puts to hedge the downside, but we don't use any in our model portfolio.

BTS: Any final advice for covered call writers?

KS: Temper your expectations. I talk to people who want all the upside and at the same time want massive current income, but that can't happen. It's a trade off. Our clients have chosen the more conservative approach where they have good (but not the highest) current income and have good (but not the highest) capital appreciation potential.

Also realize that success with covered calls is not about a single trade. It's a long term strategy for life. Make a commitment to it and then apply it consistently over time. Studies have shown that it is a long term winning strategy.

Lastly, if you have a smaller account then consider ETFs instead of individual stocks. Since you need to own 100 shares of something to write a covered call on it, getting proper diversification in a small account that only owns stocks can be difficult if not impossible.

BTS: Great. Thanks for your time today, Kevin. [Side note: the Born To Sell screener has an "Only ETFs" check box that saves you time in finding ETFs to write calls against by removing individual stocks from the results table. Look for it under "Advanced Filters"]

For more information on this actively managed ETF covered call strategy, please visit Capital Wealth Planning or ask your broker ($100K minimum).

Disclosure: This is not an endorsement to buy or sell securities. Investing in securities carries with it very high risks. The information contained within this interview is for informational purposes only and is subject to change at any time. Do your own due diligence and consult with a licensed professional before making any investment. Born To Sell has no affiliation nor has received any compensation from anyone or any company mentioned in this interview.

Mike Scanlin is the founder of Born To Sell and has been writing covered calls for a long time.