Daijiworld Media Network – Tokyo

Tokyo, Aug 3: In a move to tap into the growing appetite for yield-enhancing strategies, Japan’s main stock exchange is pushing to allow listings of actively managed exchange-traded funds (ETFs) that use over-the-counter (OTC) derivatives, such as swaps and options.

The Tokyo Stock Exchange (TSE) is seeking regulatory approval to list such funds by June next year. Currently, Japanese ETFs are restricted to listed instruments like those on Osaka’s derivatives market, but the exchange now wants flexibility for OTC instruments as well, said Kei Okazaki and Ryutaro Someya from the TSE’s new listings department.

One of the key drivers is the increasing popularity of call overwriting — or covered call strategies — where investors who own shares sell call options to earn premiums. While this strategy is common globally, it has found renewed interest in Japan, where interest rates remain among the lowest in the developed world even after the central bank ended its zero-rate regime.

“Banks and insurers are seeking yield as they now have to pay more interest to their clients,” said Okazaki. “Covered call strategies offer regular and stable income.”

Currently, the Japanese market for listed covered call products is worth around ¥35 billion, but the TSE expects it to grow to more than ¥1 trillion ($6.8 billion).

Additionally, the exchange is proposing that ETFs using options be allowed to pay out dividends using the premiums earned, further boosting returns for investors. A spokesperson for the Financial Services Agency (FSA), which regulates ETFs and investment trusts, declined to comment on the proposal.

Globally, the covered call trade is one of the most popular volatility strategies. BNP Paribas' Georges Debbas noted that large institutions automate these trades, and several actively managed ETFs already employ them.

However, experts caution that while call overwriting thrives in stable or falling markets, it limits upside potential during rallies, as options may be exercised, forcing the seller to part with the underlying stock. Moreover, clustering around certain option strikes can suppress market volatility or create resistance points, although most institutional funds space out their trades to avoid such risks.

Geoff Kirk of Premier Miton said asset managers are highly conscious of “pin risk” — the pricing uncertainty near option expiry — and banks enforce strict risk limits on such trades.

JPMorgan strategists observed that covered call ETFs performed well during market downturns but lagged in strong recoveries, highlighting the importance of timing and selectivity.

Tanvir Sandhu of Bloomberg Intelligence summed up the strategy's appeal, writing: “Selling call options can provide income, especially when there is an expectation that a market rally will stay within a defined range during the option's life.”