HMAX ETF is a new fund offered by Hamilton ETF. The fund invests in the Canadian banking sector. This fund aims to provide an attractive dividend yield (target 13%) using a covered call strategy. The strategy consists of writing call options on (50% of the portfolio) to collect premiums and maximize monthly distributions. This post discusses the strategy used and compares HMAX to ZWB from BMO (BMO Covered Call Canadian Banks ETF).
This post is available in video format!
How HMAX is able to set such high dividend yield target?
According to the issuers’ website, HMAX is able to provide higher monthly income for two reasons:
- HMAX writes covered call options on approximately 50% of the portfolio
- The fund is currently writing option At The Money (ATM) wheras similar funds are writing options OTM (Out of The Money).
Analysis
1- HMAX writes covered call options on 50% of the portfolio
The first point means for as an investor; you will benefit from growth potential on only 50% of the portfolio. The 50% on which the covered call strategy is applied, the growth potential (capital gain) is replaced by a monthly income consisting of dividends and option premiums. These premiums are earned each time the fund sells a call option in the market. Overall, HMAX ETF is a hybrid fund; 50% of it looks like a classic dividend fund. Dividends and long-term appreciation of the portfolio are to be expected. The other 50% is more conservative and primarily seeks income with no potential for portfolio appreciation.
2- The fund is currently writing option At The Money (ATM) wheras similar funds are writing options OTM (Out of The Money).
I invite you to consult the table below to understand the second point. As you can see, the HMAX fund has chosen to issue ATM call options because they are more profitable than OTM options. First, the premium is higher than that generated by an OTM strategy. However, the risk of loss is also higher.
The risk for an option always corresponds to the probability that the buyer will exercise it. If the strike price is higher than the current price (OTM), the chances of the option being exercised are low. However, the probability of the option being exercised is more plausible for an ATM option where the strike price is very close or equal to the stock’s current price.
Tables
| Premium or option price | Risk | Reward | |
| ITM (In the money call option) Stock price > Strike price | High | High | High |
| OTM (Out of the money call option) Stock price < Strike price | Cheap | Low | Low |
| ATM (At The Money call option) Stock price = Strike price | Medium | Medium | Medium |
Option premium = Intrinsic value + Time value
| ITM | ATM | OTM | |
|---|---|---|---|
| INTRINSIC VALUE | YES | NO | NO |
| TIME VALUE | YES | YES | YES |
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ZWB vs HMAX ETF
Strategy
The ZWB ETF from BMO sells out-of-the-money (OTM) call options on 50% of the stocks. The OTM strategy caps the return of the written positions at the option strike price until the option expires. Generally, for BMO ETFs, option expiries are 1 to 2 months.
| % potfolio | Option strategy | Divdend Yield | |
| ZWB | 50% | OTM | 6-7% |
| HMAX | 50% | ATM | 13%* |
Portfolio allocation
| Big Can Banks | Insurance | Asset Management | |
| HMAX | 76.4% | 14.9% | 10% |
| ZWB | 100% | – | – |
Video
Why covered call ETFs are popular?
Covered call ETFs are very popular with Canadian investors. Some of these ETFs managers have billions of dollars under management. Two reasons push investors towards covered call ETFs:
High dividend yield: thanks to the premiums earned when writing call options, the manager under certain conditions can earn premiums and enhance distributions;
Low volatility. Writing a call option is a conservative strategy aimed at reducing volatility;
Great for passive income: if you’re main objective is to achieve high dividend yields and build passive income, then covered call ETFs are a good option. But, remember the high dividend yield comes at a price which very low growth potential.
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HMAX Dividend Schedule
HMAX ETF plans to pay monthly dividends. The first distribution is expected to be for the month ended February 28, 2023. The distributions are paid monthly in cash.
| EX-DIV DATE | PAID | FREQUENCY | AMOUNT |
|---|---|---|---|
| 2023-02-27 (Estimated) | 2023-03-10 (Estimated) | Monthly | $0.185 |
HMAX ETF Holdings
| NAME | WEIGHT |
| Royal Bank of Canada | 23.1% |
| Toronto-Dominion Bank | 20.5% |
| Bank of Montreal | 11.5% |
| Bank of Nova Scotia | 10.5% |
| Brookfield Corp | 10.0% |
| Canadian Imperial Bank of Commerce | 6.7% |
| Manulife Financial | 6.0% |
| Sun Life Financial | 4.8% |
| Intact Financial | 4.1% |
| National Bank of Canada | 4.1% |
HMAX ETF sector allocation
█ Asset Management 10.0%
█ Banks 76.4%
█ Insurance 14.9%
Is there fees from Hamilton ETF when share of that EFT are sold. The prospectus indicate when sahre are sale at a value 95% of share value. Does that means Hamilton take 5% of the shares are sold?
Thanks for this good video. Can you please comment on erosion of capital over time with HMAX . It *appears that HMAX’s ATM option strategy might erode capital more than a “safer” OTM fund. I am ok with little or no capital gain when focused on a high income ETF, but the last thing I want is steady erosion of capital over time. Your thoughts on what the ATM option strategy does to put capital at risk is appreciated.
All of these ETFs are legal scams, Hyld is a classic one, declining NAV and high pay out which is all destructive return of capital. If you’re using the money for other things such as expenses and don’t reinvest distributions these are basically just legalized Ponzi schemes.