Income remains top of mind for financial advisors. But increasingly, it’s not just about generating more yield. Advisors are also looking for ways to manage taxes, reduce portfolio volatility, and preserve long-term growth. Those priorities were front and center during a recent VettaFi webcast, “The Evolution of Income Investing: What Advisors Need to Know”, where Garrett Paolella, co-founder, managing partner & portfolio manager at NEOS Investments and Wes Matthews, executive director investment specialist at NEOS discussed a new generation of options-based ETFs.
Key Takeaways
- Options-based ETFs have grown to more than 915 funds.
- Generation-two covered call strategies use Section 1256 index options and active tax management to help convert distributions into tax-deferred Return of Capital (ROC).
- Adding options overlays to traditional portfolios can increase portfolio income while lowering overall volatility and beta.
Advisor Demand Fuels the Next Generation of Options-Based ETFs
The category has grown rapidly, expanding to more than 915 funds and attracting over $213 billion in trailing three-year flows. That growth reflects a broader shift in how advisors are using covered call strategies. Rather than sacrificing upside in exchange for income, many are turning to generation-two approaches designed to strike a balance between capital appreciation, tax efficiency, and consistent cash flow.
During the webcast, polling revealed that 40% of advisor attendees view generating reliable income as their primary focus, closely followed by managing market volatility and long-term growth.
Matthews on Generation-Two Covered Calls
The biggest distinction between traditional covered call funds and newer options-based ETFs lies in how options are written and how taxes are managed.
Matthews explained that legacy covered call products often cap upside potential and trigger taxable ordinary income. While that approach can generate meaningful income, it also limits upside participation and often results in distributions taxed as ordinary income.
Generation-two strategies take a different route by writing index options that qualify as Section 1256 contracts. Those contracts receive blended tax treatment, with 60% of gains taxed as long-term capital gains and 40% as short-term gains regardless of the holding period.
Managers also actively harvest losses throughout the year by writing options roughly seven weeks before expiration and rolling positions monthly. During rising markets, realized option losses can offset gains, allowing a larger share of distributions to be classified as Return of Capital (ROC). Because ROC isn’t immediately taxable, investors can defer taxes until they eventually sell their shares.
According to NEOS, Return of Capital represented nearly 95% of distributions for the NEOS S&P 500 High Income ETF (SPYI ) and more than 99% for the NEOS Nasdaq-100 High Income ETF (QQQI ) in 2025.
Options-Based ETFs Expand Beyond Income
Paolella outlined how NEOS organizes its lineup into four portfolio building blocks designed to align with specific advisor risk tolerances.
For core equity income, SPYI writes out-of-the-money index call options on roughly half of the portfolio, targeting annualized distributions of 8% to 15% while preserving meaningful upside participation. Advisors seeking higher income can move up the risk spectrum with the NEOS S&P 500 High Income Boosted ETF (XSPI), which uses options-based leverage to target annualized yields between 15% and 23%.
On the more defensive end, the NEOS S&P 500 Hedged Equity Income ETF (SPYH ) allocates a portion of option premium to downside put spreads, pairing explicit market protection with target distributions of roughly 6% to 9%.
Beyond equities, NEOS also offers options-based income strategies across alternative and fixed income exposures, including the NEOS Enhanced Income 1-3 Month T-Bill ETF (CSHI ), the NEOS Gold Income ETF (IAUI ), and the NEOS Bitcoin High Income ETF (BTCI ). Fixed income strategies such as (CSHI ) seek to generate an additional 1% to 2.5% in annualized income by selling out-of-the-money SPX put spreads without materially changing the underlying bond portfolio’s duration profile.
Portfolio Construction Moves Beyond the Traditional 60/40
Rather than replacing core holdings, advisors are increasingly using options-based ETFs as portfolio overlays that can be tailored to specific client needs.
During the webcast, Paolella demonstrated that replacing half of a core equity allocation with SPYI elevated overall portfolio yield from 2.19% to 5.49% while reducing standard deviation. At the same time, portfolio standard deviation declined from 7.32% to 6.45%, while beta fell from 0.62 to 0.54, suggesting stronger income generation alongside lower overall portfolio risk.
The strategies are finding applications across both taxable and tax-advantaged accounts.
For taxable investors, high Return of Capital distributions can defer taxes until shares are sold, potentially improving after-tax outcomes. Matthews later added that in qualified retirement accounts, advisors can use higher-yielding options-based ETFs to help clients meet Required Minimum Distributions (RMDs) without liquidating as much principal, allowing more assets to remain invested for future growth.
As advisors continue to prioritize income alongside tax efficiency and downside management, options-based ETFs are evolving from niche income products into flexible portfolio construction tools. Their expanding role reflects a broader shift in wealth management, where generating cash flow is increasingly paired with preserving long-term investment outcomes.
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