REITs vs Covered Call Funds
REITs own property and are required to distribute most of the rental income they collect, so the yield comes from an external cash flow. Covered call funds hold assets and sell call options against them, so the yield comes from giving away the upside above the strike price.
Both of these are bought for income and the income comes from opposite places. One collects money from tenants and passes most of it on. The other sells a right to your future gains and passes on the proceeds, which looks identical on a yield screen and is a completely different transaction.
What each one is
A REIT owns income-producing property and is required to distribute the large majority of its rental income, which is why the yields are high. REITs covers the structure.
A covered call fund holds assets and sells call options against them, collecting premium and distributing it. Covered call funds covers the mechanism, and ETF investing covers the wrapper both use.
One yield is external and the other is internal. Whereas rent arrives from tenants who are not you, option premium is payment for surrendering gains that would otherwise have been yours — the money comes out of the position’s own future.
Where they differ
Where the money originates. A REIT’s distribution was paid by a tenant. A covered call fund’s distribution was paid by an option buyer, in exchange for the fund’s upside above a strike — so the higher the distribution, the more upside has been sold.
What happens in a strong rise. A REIT participates in property values rising. A covered call fund does not participate above its strikes — it collected the premium instead, so it underperforms a plain holding in exactly the periods a plain holding does best. That is the design, not a fault.
What each is sensitive to. REITs borrow to buy property, so rising interest rates hurt them twice — financing costs rise and property valuations fall. Covered call funds are sensitive to volatility: option premium is higher when markets are jumpy, so the yield rises in conditions people find alarming.
What the downside looks like. Neither protects much. A covered call fund keeps the full fall below the strike and gave away the recovery above it, which is the asymmetry that matters and the one the yield figure conceals.
Where they agree
Both distribute a lot, which is the reason people hold them and the reason both are usually better held inside a tax wrapper.
Both charge an ongoing fee that compounds: over thirty years, 20 basis points removes 5.8% of a pot and 75 removes 20.2%.
Both fall in a market decline. On this site’s shared series 95% of bars sat below a prior peak, with the longest wait for a new high at 73 bars.
And neither is a bond substitute, though both are frequently bought as one.
Which one to use
Use REITs when you want exposure to property income. The yield is produced by an asset doing something, and the underlying rent is a genuinely different source of return from the shares that dominate most portfolios.
Use a covered call fund when you expect the market to go sideways and you want cash from a holding that would otherwise produce none. In a flat market the sold upside was worth nothing, so the premium is close to free — that is the one condition where the trade clearly favours you.
Use REITs when interest rates are the thing you have a view on, since they are unusually sensitive to it in both directions.
And when you need income and cannot tolerate a capped recovery, take neither. Both fall with markets, and one of them cannot fully recover.
Why a headline yield hides the trade
Because yield and total return are different measurements. A fund distributing a large percentage while its price declines has a high yield and a poor result, and the screen that ranked it showed only the first number.
And because the cap bites hardest at the recovery. After a decline, the sharpest rises are the ones a covered call fund is least able to capture, so the strategy’s weakest moment coincides with the market’s strongest.
The original data
Of the 24,971 unique videos in the search corpus, no title compares these two directly. REITs appear in 15 titles at a median of 92,645 views across 12 channels — one of the highest medians measured anywhere on this site. Covered calls appear in 17, at a median of 31,993 across 17.
Fifteen videos and a ninety-thousand median. Property income is one of the most sought and least supplied subjects in the corpus, and covered calls sit in a similar position — under twenty videos each, both with large audiences, which is the clearest under-supply signal in the income category.
On the chart above the yields match and the sources do not. That is the entire content of this comparison, and no income screen distinguishes them.
When it fails
The characteristic failure is buying a covered call fund for its yield in a rising market. The distribution is high precisely because a great deal of upside was sold, so the holder receives cash while the price stagnates below where an uncapped holding would be — and because the income arrives reliably, it looks like the strategy working. The shortfall appears only in total return, over years, against a plain index holding, and by then a considerable amount of compounding has been converted into distributions that were spent. The fund did exactly what it promised and the buyer measured it with the wrong number.
A second failure is treating either as a bond substitute. Both fall with equity markets.
A third is holding either outside a tax wrapper without checking the treatment, since heavy distributions can be taxed less favourably than gains.
A fourth is buying REITs without regard to interest rates, which affect both their financing and their valuations.
And a fifth is ranking either by yield alone, which is the measurement that hides the trade being made.
Related
REITs covers property income and its rate sensitivity. Covered call funds covers where the distribution comes from. And ETF investing covers the pooled wrapper both use.
The covered call fund’s yield is the part people misread. It is not income the asset produced, it is money received for agreeing to cap your gains — so a large distribution during a rising market is you being paid out of your own future return, and the headline percentage says nothing about whether that was a good trade.
— Michael Whitman
This page is educational, not financial advice. Test every idea on your own charts before risking money.