Understanding Return of Capital (ROC) in ETFs

Return of capital (ROC) is a distribution an investor receives, representing a part of the investor’s initial investment and distinct from income or capital gains generated by the investment. It is crucial to recognize that a return of capital reduces an investor’s adjusted cost basis. Once the adjusted cost basis of the stock reaches zero, any subsequent return of capital becomes taxable as a capital gain.

Return of capital refers to investors receiving a portion of their initial investments, potentially reimbursing investors with their entire initial investments, occurring regularly, be it monthly or quarterly, alongside other income distributions like dividends. Capital gains only materialize upon the sale of ETF shares (unless the adjusted cost basis is zero as described above), with the potential for substantial gains given the gradual reduction of the cost basis each year. This dynamic sets the stage for potentially enhanced capital gain opportunities when the shares are eventually sold.

Defiance’s series of options-based income ETF’s endeavor to allocate a segment of monthly income distributions from the sale of index option premiums, with the ultimate potential of converting the monthly distributions into capital gains.

ZEGA’s seasoned portfolio management team steering the ETFs brings decades of expertise in developing and overseeing options-based ETFs. The team actively seeks opportunities within each ETF’s portfolio to identify losses that can offset gains, potentially designating a portion of distributions as return of capital.

An intriguing feature in the ETF product structure is the ability to carry forward portfolio losses indefinitely, strategically deploying them to offset gains in the ETF’s equity or option portfolios during opportune times.

As with any investment, investors are advised to thoroughly assess the associated risks and benefits before making decisions.