JPMorgan Equity Premium Income (ASX: JEPI) takes a nuanced approach to covered calls that delivers high income while reducing downside risk. This fund’s incremental improvements on a basic covered-call strategy make it a solid option in the derivative income Morningstar Category, though income from covered calls generally isn’t tax-efficient.

This fund owns a defensive stock portfolio that targets stocks from the S&P 500 while systematically selling one-month call options on the index. The fund uses slightly out-of-the-money calls, leaving modest room to capture the index’s upside. Manager Hamilton Reiner staggers the one-month calls into multiple weekly buckets to diversify the expiration date and strike prices. However, he doesn’t directly write these calls for the fund. Instead, he purchases equity-linked notes that provide exposure to the profits on those call options. This simplifies the fund’s tax treatment but precludes it from taking advantage of lower long-term capital gains tax rates. Reiner’s team alleviates counterparty risks on the ELNs by spreading trades across multiple issuers and limiting transactions to global financial institutions that pass its regular risk monitoring. It regularly tests pricing and liquidity on the ELNs to ensure they’re getting the best deal.

In general, covered-call funds have not been the best buy-and-hold investments for investors with a longer time horizon. The stock portfolio’s upside is capped, and the downside remains exposed to significant drawdowns, which can erode an investor’s long-term total returns. Even for investors with high income needs, there may be more tax-efficient options available, such as selling investments with long-term capital gains. However, covered-call funds provide a simple way to outsource this task and can alleviate problems that come with self-implementation.

This strategy’s options income offsets some losses incurred during drawdowns, and higher implied volatility during these periods often translates to higher call premiums and higher income. The stock portfolio is less sensitive to the market’s movements, which further lessens the sting. It beat the index significantly during the 2022 market meltdown and volatile periods earlier in 2025. Shorting call options means long-term returns don’t measure up to the S&P 500, though the fund still outperformed both the category index and category average since its 2020 inception.

Investment process

The portfolio has two components: a stock sleeve and an options sleeve. The managers construct the equity sleeve to reduce volatility. They try to capture about 80% of the S&P 500’s fluctuations, or a market beta of 0.8. They leverage earnings forecasts from the broader team of J.P. Morgan analysts to build the stock portfolio. Their quantitative forecasts drive selections and weightings, while their qualitative subject matter expertise helps contextualize sources of equity risk and market events. No sector can account for more than 17.5% of the portfolio, and no single position can exceed 1.5% at each rebalance, which prevents any single sector or stock from having an outsize impact.

For the options sleeve, this fund sells out-of-the-money calls on the S&P 500 with one month to expiration. The managers use a fixed delta to determine the strike prices, creating a systematic process while letting the strike prices fluctuate with market conditions. The options’ strike prices tend to increase further out of the money during periods of elevated volatility, typically during market downturns and when interest rates are high. Historically, this figure has hovered around 2% above the index price. The manager ladders the calls in weekly buckets to alleviate market impact costs of their option trades and diversify the strike price and expiration date.

The fund packages its calls into an equity-linked note instead of directly selling the call options. This structure allows the fund to pass through all the premiums it earns for investors as dividends. Depending on market conditions, peers directly using call options will distribute part of their premiums as capital gains and return of capital, which is not taxable income but reduces an investor’s cost basis in the fund. There is a trade-off between these two approaches. The fund loses the ability to recognize a portion of the premiums as long-term capital gains, whose tax rate is more favorable. However, its higher-than-average payout should compensate for this tax treatment for most investors in lower tax brackets.

The use of ELNs invites additional counterparty risk. The fund invests around 15% of its assets in ELNs, which lands below the 20% regulatory cap. It spreads each trade across four to five issuers and usually has exposure to seven to nine issuers at any given time, or well under its 5% issuer limit. The management team is only allowed to transact with large global financial institutions, typically global systemically important banks. They purchase ELNs from issuers offering the best income through a competitive auction process, which should tame commissions.

Covered calls effectively cash in on a fixed rate of the index’s upside. These payouts help cushion the strategy’s performance during downturns and add value during sideways markets when the index does not breach its strike price. The defensive stock sleeve should also dampen the sting during market shocks. However, selling call options caps the strategy’s upside roughly at the strike price of the call plus its premium. This hurts relative performance during market rallies or when lower implied volatility suppresses premiums. In addition, the lower-risk stock sleeve might not keep up with the S&P 500 during rallies. This can cause the fund to underperform a traditional covered-call strategy that simply holds S&P 500 stocks in those periods.

This stock portfolio tends to underweight mega-cap names and high-growth sectors relative to the S&P 500 owing to its sector and position limits. It also excludes a sizable number of larger index constituents that it considers too expensive or volatile. Instead, the portfolio allocates to smaller companies with reasonable valuations. So far, the stock portfolio has provided protection in some of the major downturns since the fund’s 2018 inception while moderately keeping up during rallies.

Stock dividends make up a minimal portion of the fund’s payout as the manager doesn’t specifically target dividend payers. The fund’s annual yield has hovered between 8% and 12% since its inception, partly thanks to recent episodes of heightened volatility and high interest rates that pushed premiums up. Its yield will likely decline as interest rates come down, but it should continue to be competitive.

Get Morningstar insights in your inbox