There’s Finally 1 Covered Call ETF I Like. Here’s What Makes It Stand Out.

Covered call ETFs have taken retail investors’ portfolios by storm over the past few years, but most of them suffer from a fundamental structural flaw: They apply an income-generating overlay to the wrong asset class. 

Products that write options against equity indexes cap your upside during bull markets while leaving you with nearly all the downside risk when stocks plunge.

The iShares 20+ Year Treasury Bond BuyWrite Strategy ETF (TLTW) turns that equation on its head. By combining direct exposure to long-term U.S. Treasuries (via TLT) with a monthly out-of-the-money covered call strategy, TLTW creates an income stream that actually makes strategic sense for long-term risk managers.

Why Stock-Based Covered Call ETFs Miss the Mark

Equities are built for long-term capital growth. When you buy an equity covered call ETF, such as those tracking the S&P 500 Index ($SPX) or Nasdaq 100 Index ($IUXX), you sacrifice the primary reason to own stocks in the first place: compounding uncapped upside. In exchange for an attractive distribution yield, you surrender participation in major market rallies.

Worse, when stock market valuations are stretched and equities trade at elevated price-earnings multiples, equity covered call strategies still leave your underlying principal exposed to full market drawdowns. You effectively trade away multi-year stock market upside for short-term income on an asset class that is already vulnerable to a deep valuation reset.

Here’s a rolling 12-month return graph of TLTW versus its underlying ETF, the iShares 20+ Year Treasury Bond ETF (TLT). In its four-year history, the only time TLTW did not outperform was during the spike in TLT a couple of years ago, which was over quickly.

That chart tells me that other than when bond rates are spiking higher, TLTW is likely to give me a smoother ride than TLT. That’s not surprising, given the covered call cushion. 

However, for income-oriented folks, the idea that there’s a boost in total return to be had during periods where rates are jockeying around is appealing. So much so that I’m likely to include TLTW in a “surrogate bond ladder” model portfolio I am building for myself and my subscribers right now. As I see it, bond returns will be more exciting than stocks for the next few years, at least. Even if rates do not top out immediately. 

What could go wrong? Years of hyper-inflation, stagflation, and more. That would trash TLT and take TLTW along with it. But the choice here is whether to engage in a potential period of a few years of battling inflation that may or may not end well. 

To me, I am still putting the odds of a sustained period of higher rates as modest. Some market pundits are starting to predict doom. I’m just not there yet, not when government forces have every incentive to get rates down. Even if they have to prompt a deep recession to do it. I know, not a pretty “base case” from me right there. 

But I still think bonds look better than stocks in that scenario. Bonds, if bought smartly, hedged proactively, and using opportunistic trading to capitalize on eventual rate drops, can at least target a 4%-8% total annual return from here, longer-term. Frankly, I don’t see the S&P 500 coming close to that. Which by the way, makes me quite a contrarian!

Why Consider TLTW?

The investment case for TLTW is entirely different because the underlying asset (long-duration U.S. Treasury bonds), behaves differently than equities. Long-term Treasuries are coming off one of the most severe multi-year bond bear markets in modern history. 

With 30-year Treasury yields (ZBU26) hovering near 20-year highs, and my belief that monetary policy will enter an eventual easing cycle, long-term bonds are positioned for a nice recovery over the next few years. One that I suspect many investors will miss, since they have been under-educated AND miseducated about bond investing. All while they chase AI stocks. 

TLTW allows investors to get paid a high distribution yield, typically near 10%, while waiting for that fixed-income normalization to play out. Unlike stocks, where corporate earnings growth is theoretically uncapped, bond yields move within ranges, determined more by macro factors than whatever the heck is driving equities during any particular week.

Selling call options on a long bond fund captures high option premiums driven by interest rate volatility, effectively converting rate uncertainty into immediate, monthly cash flow for your portfolio. As you can see here, TLTW is super simple. A monthly call written against the bond portfolio. For context that current option is struck at $85, while TLT closed at $82.88 on Friday.

TLTW vs. TLT: Outperforming in a Range-Bound World

During prolonged periods of choppy, sideways bond market action or gradual rate drift, buy-and-hold TLT can be a painful position to sit in, offering only its baseline coupon yield while carrying significant duration volatility. TLTW has consistently demonstrated its value in these environments by using option premiums to cushion total returns compared to unhedged TLT.

For income-focused investors who seek exposure to long-duration Treasuries without taking unhedged directional bets on daily rate headlines, TLTW can be a viable middle ground. It transforms long-term Treasury volatility from a portfolio headache into a reliable monthly yield machine. I have used it here and there in the past, but I am looking at it with much more intrigue now. 

Rob Isbitts is a semi-retired CIO, former fiduciary investment advisor, and Barchart columnist. Check out his other work at ETFYourself.com (featuring the Fresh Charts weekly trading post), and ROAR.PiTrade.com, helping investors to better-manage their own portfolios.