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     Blue Chip Income

 

Methodology:

By combining two standalone model portfolios with a covered call ETF, the Blue Chip Income portfolio aims to achieve its goals of high current income and capital appreciation. The Capital Leaders segment of the model tends to perform well when the broader stock market performs well. Conversely, when the market performs poorly, the Daily Essentials segment tends to pick up the slack due to the defensive nature of the stocks within the segment. This inverse correlation between these two segments offers diversification to the overall Blue Chip Income model, which we believe benefits the model’s performance in the long run. Finally, the covered call ETF will continue churning out dividend payments regardless of the market’s performance. However, the ETF’s dividend payments tend to be affected by the level of volatility in the market. With higher volatility usually comes higher dividend payments, and vice versa.

 

Covered Call ETFs Explained

Covered call ETFs are a type of ETF that uses a strategy called “covered call writing” to generate income for investors. Here’s a breakdown of how they work:

 

  1. Building the Basket:
  • Imagine a basket full of apples (stocks). A covered call ETF starts by holding a basket of various stocks, similar to a regular ETF that tracks a specific index.
  1. Selling Call Options:
  • Now, the ETF doesn’t just hold the apples (stocks). They also sell “call options” on some (or all) of those apples.
  1. Call Options Explained:
  • Think of a call option like a coupon for a specific apple at a set price. The buyer of the call option gets the right, but not the obligation, to buy a certain number of shares (usually 100) of the stock at a predetermined price (strike price) by a certain date (expiration date).
  1. Income from Premiums:
  • By selling these call options, the ETF collects a premium from the buyer. This premium is like a fee for giving the buyer the right to purchase the stock later. It’s like getting paid upfront for holding those apples. This is how the ETF generates the large dividend.
  1. Potential Scenarios:
  • Stock Price Goes Up (But Below the Strike Price): This is a good scenario for the ETF. They keep the apples (stocks) and get to enjoy the price increase. They also keep the premium they earned from selling the call option.
  • Stock Price Goes Up and Breaches Strike Price: If the stock price shoots up above the strike price by the expiration date, the call option becomes very valuable. The buyer might exercise the option, forcing the ETF to sell the apples (stocks) at the lower strike price (limiting potential gains on the stock). However, they still get to keep the premium as a consolation prize.
  • Stock Price Goes Down: Even if the stock price falls, the ETF isn’t obligated to sell anything. They simply hold onto the apples (stocks) and keep the premium they earned earlier.

 

Overall:

  • Covered call ETFs aim to generate consistent income through premiums while offering some protection against a declining market (since they still hold the stocks).
  • However, they also limit potential gains if the stock price significantly increases.