2 Covered Call ETFs To Shield Your Income From An AI Crash

For some years now, I have been cautioning dividend-oriented investors about their explicit and implicit exposures to the AI trade. I know that debating growth investors who are mostly bullish on AI and indifferent to current income is largely futile. I’m not saying that either camp is right. Each strategy has its own unique advantages and disadvantages that work for certain investors.

In fact, the history and financial theory say that exactly the trades that carry the highest expected return per unit of risk (volatility) are the ones that should be prioritized in the context of maximized value creation. The past 10 years or so have been all about the technology stocks (low yield, high growth), such as Nvidia Corporation (NVDA), Tesla, Inc. (TSLA), and Apple Inc. (AAPL). Old economy, yield-oriented assets have clearly lagged the growth factor. Plus, however much one dislikes the AI trade, it is highly likely that, in the long run, the strongest growth will come from this technology-driven arena.

However, when it comes to yield-based investors, I have tried to be vocal by consistently feeding in various not-so-obvious risk angles that, in my view, are unnecessary, avoidable, and potentially deadly for durable income extraction.

The way I’m thinking about a dividend-oriented strategy and its ultimate objectives can be nicely captured by the efficient frontier theory. The official theory defines returns as expected total return (price + dividends) from a specific asset and risks as the expected standard deviation (price volatility) of the same asset. The most efficient and rational investments are the ones that generate the highest ratio when dividing expected returns with the expected standard deviation metric. My philosophy, however, entails replacing expected total returns with expected dividend income, and the risk part is replaced by the expected economic return volatility, which is comprised of dividend vol and NAV vol. This way, the logical approach is to maximize yield per given unit of risk, where risk has nothing to do with price volatility but instead dividend and NAV volatility.

Now, how does all this tie to the AI risk? The thing is that there are only two noteworthy pathways for how yield-seeking investors can integrate the AI exposure in their portfolios:

1. AI-linked covered call ETFs, which typically are underpinned by either the S&P 500 (SPY) or the Nasdaq-100 (QQQ) indices.
2. Select AI-linked closed-end funds that distribute high income by relying on the capital appreciation of the underlying AI-related stocks – e.g., Adams Diversified Equity Fund, Inc. (ADX).

What I have observed is that just too many income investors have overexposed their portfolios to the AI factor through such covered call ETFs as the NEOS Nasdaq-100 High Income ETF (QQQI), the JPMorgan Equity Premium Income ETF (JEPI), the JPMorgan Nasdaq Equity Premium Income ETF (JEPQ), and the Goldman Sachs Nasdaq-100 Premium Income ETF (GPIQ). These instruments tend to go on top of pure-play technology holdings and certain AI-biased CEFs.

In my view, this creates unnecessary risk where a notable chunk of the total portfolio income flows from an inherently volatile source. Remember if the AI stocks sell-off and plunge into a long bear market, the AI-enabled covered call income streams (including those of certain CEFs like ADX) will generate significantly smaller dividends.

I’m not saying that income investors should avoid this factor at all costs. Instead, I’ve been just advocating for an underweight total exposure (including AI-biased covered call ETFs) – say, max 15% of the total portfolio income generation.

One of the biggest push-backs I hear is that this move required sacrificing yields. I think that this could not be further from the truth.

So, let me share two of my favorite covered call ETFs that investors could utilize to rotate out of AI and into a much more compelling and logical factor.

2 Covered Call ETFs to Hedge Against the AI

I don’t want to sound like a broken record, but I really think that we are closer to the end than the start of an AI bull cycle. We’re in the 4th consecutive year of a double-digit bull run, which is a statistically rare outcome that sits well outside the centre of the normal distribution. Each day that goes by introduces a higher mathematical probability of a notable pullback. And it is not just the statistics that work against the trade. The fundamentals have started to become increasingly shaky. The credit default swap rates of CoreWeave (CRWV), SpaceX (NASDAQ: SPCX), and Oracle (ORCL) are sending a worrying message, which I think we should respect given the fact that the credit markets tend to be much smarter than sentiment-driven equity markets.

The previous week was a fun one too. Take a look at the following chart, which reflects my two covered call ETFs that I would like to suggest for investors and select stocks that I associate with huge AI optimism:

 

The Nasdaq-100 has materially declined, but the most aggressive AI-trade stocks, such as CoreWeave, Nebius Group (NBIS), Strategy Inc (MSTR), Palantir (PLTR), and Micron Technology, Inc. (MU), have suffered just so much more.

Yet my two preferred covered call ETFs – the VistaShares Target 15 Berkshire Select Income ETF (OMAH) and the Amplify CWP Enhanced Dividend Income ETF (DIVO) – have both held steady as a rock.

This is the beauty of a value-oriented covered call ETF tilt that I’ve been trying to recommend for income investors. First, these types of covered call ETF vehicles offer very competitive yields, and second, they offer the necessary protection against the AI sell-off.

At their core, OMAH and DIVO are rather similar instruments because they both derive value from the same factor – high-quality value.

OMAH is a 15% target yield covered call ETF which calibrates its call-writing tactics in order to deliver on the set income objective. The covered calls are written on an out-of-the-money or OTM and individual security basis. The portion of the underlying value that is overlaid with a covered call underwrite is variable and driven by the 15% target yield result. For example, the higher the implied vol, the higher the core dividends and the bigger the price appreciation of the underlying stocks, the less aggressive OMAH has to be on its covered call writing front.

The main advantage of OMAH in the context of AI hedging lies in its portfolio construction, which is effectively a replica of the high-quality value poster child: Berkshire Hathaway Inc. (BRK.A) (BRK.B). Namely, OMAH has synchronized its holdings with BRK’s value-oriented equity portfolio:

 

DIVO’s covered call writing differs. First, DIVO doesn’t have a strict yield target. Second, DIVO doesn’t write covered call contracts on all of its underlying book (hence, it retains a bigger upside potential in the system). Third, DIVO has a different portfolio construction strategy. Rather than replicating a high-quality value powerhouse as BRK, DIVO implements a bottom-up process in order to arrive at the highest quality stocks:

 

Take a look at DIVO’s Top 10 holdings:

 

These have undoubtedly a stronger dividend growth tilt than the holdings we saw in BRK’s case. In my view, a high-quality value factor with a cash-flow-driven dividend growth spin could actually act as an even better shelter from the downfall in the equity growth arena. This way the fleeing growth investors could strike a balance between a fundamental resiliency from the value tilt and a durable growth from the EPS perspective. On top of that, DIVO’s advantage is that it writes covered calls on a select security basis, leaving the majority of the underlying asset base fully open to an upside capture. In moments like we saw in the previous week, this doesn’t add value. However, we’ve to be mindful of the “buy-the-dip” mentality that exists in the market and that could potentially (highly likely actually) quickly drive up the market to new all-time highs. So, here DIVO’s relaxed covered call writing could limit the opportunity costs. That said, this comes at the cost of a juicy dividend yield, which for DIVO stands at 6.3% as opposed to OMAH’s 15.3% and ~10% that is associated with AI-driven covered call ETF alternatives.

Final Words

For income-oriented investors, who have become overly exposed to the AI factor through direct investments in AI stocks, AI-linked covered call ETFs, and/or CEFs, the instruments such as OMAH and DIVO offer a great way to keep dividends high while exchanging the risky AI factor with a value-oriented hedge. With valuations stretched and credit markets flashing warning signs, I think that now seems a prudent time to make that shift. Last but not least, as I articulated in the piece above, by suggesting this rotation, I’m not saying that all AI exposures should be abandoned. Instead, I’m suggesting that investors consider reducing the exposures to an underweight level, which, in my book, is maximum 15% of the total portfolio income.

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