CSHI: T-Bill And Option Spreads ETF, 6.2% Yield (NYSEARCA:CSHI)

Two weeks ago, I wrote about the Simplify Enhanced Income ETF (HIGH), which invests in T-bills and equity option spreads. HIGH offers investors a strong 9.4% distribution yield, with low realized volatility and drawdowns.

A few days after writing on HIGH, I came across the Neos Enhanced Income Cash Alternative ETF (NYSEARCA:CSHI), which follows a similar, somewhat less aggressive strategy. CSHI offers investors a good 6.2% distribution yield, at very low realized volatility and drawdowns. The fund should see low single-digit losses during a particularly severe bear market, although this has yet to occur. I rate the fund a buy but do consider the (small) risks the fund is exposed to.

CSHI – Holdings and Strategy

First, an in-depth look and explanation of CSHI’s holdings and strategy.

CSHI invests most of its portfolio in simple T-bills. In most cases, these securities do not yield a significant amount, but right now they do and generate most of the fund’s income and returns.

CSHI also invests or trades in S&P 500 put option spreads. Although their market values tend to be tiny, they have a moderate impact on fund income and returns. Let’s have a closer look at a specific option spread, to see how these work. Fund holdings below, spread in question highlighted:

In the example above, CSHI bought and sold a put option to the S&P 500. Selling the put option gives CSHI’s counterparty the right, but not the obligation, to sell S&P 500 shares for $4,325 on 1/11/2024 to CSHI (indexes do not technically have shares, but let’s assume they do in the example). In other words, CSHI might be obligated to buy S&P 500 shares at said price and date.

CSHI’s counterparty would only exercise the said option if doing so were profitable, which occurs when the strike price is higher than the market price. As an example, if the S&P 500 were to plummet to $1,000 per share, CSHI’s counterparty would buy shares at $1,000, and force CSHI to buy at $4,325, netting $3,325 in profits per share. Conversely, CSHI would suffer losses of $3,325 per share in this scenario, as it would be buying shares valued at $1,000 for $4,325.

In exchange for (potential) losses and risk, the fund receives a small premium from their counterparty. Figures vary, but these seem to amount to around 1.0% – 1.5% per year, on net.

An issue with selling put options is that significant declines in price might lead to significant losses. To remedy these issues, the fund focuses on short-term options which are out-of-the-money. These would only see losses from very large, and sharp, S&P 500 drawdowns. As an example, for the option above to see losses, the S&P 500 would have to drop over 10.2% in a little over a week. For reference, markets dropped 12.1% in the last week of February 2020, during the onset of the coronavirus pandemic.

Another way CSHI minimizes potential losses from selling put options is through buying another put option, this one with a lower $4,100 strike price. Said position allows the fund to (potentially) unload unwanted S&P 500 shares at a pre-determined price, eliminating the possibility of significant, outsized losses.

As an example, let’s assume that the S&P 500 drops to $1,000 per share. CSHI would be forced into buying at $4,325 per share, due to the put option they sold. CSHI would then sell these shares at $4,100 per share, due to the put option they bought. Losses would equal $225 per share. Losses would be somewhat low, and much lower than without the put.

In exchange for (potential) reductions in losses, the fund must pay a premium to buy the put option above. These are smaller than the premiums received from selling a put, so the spread generates net income/premiums.

CSHI’s spreads are all extremely similar to the one above. Only strike prices and expiration dates vary.

The fund’s strategy has two important effects.

First, it generates a small amount of option premiums. Combined with hefty T-bill coupons, these boost the fund’s yield to 6.2%:

From the above, one can estimate option premiums at around 1.2% per year. This is from distribution yield, which includes option premiums, minus 30-day SEC yield, which does not. At the same time, the fund yields 6.2%, of which 5.4% comes from T-bill yields, 5.0% after expenses. Logically, the other 1.2% comes from option premiums.

Second, the fund should see some small losses if the S&P 500 were to post significant losses in a very short amount of time. Right now, and as per my calculations, the fund would see losses of up to 4.4% if the S&P 500 were to drop by over 10.2% in a bit more than a week. Specific figures vary as the fund rolls over its spreads.

In most cases, these spreads generate a small amount of income without any realized losses. Due to this, the fund should tend to outperform T-bills at a comparable level of risk, as has been the case since inception.

During particularly severe bear markets, these spreads should post losses, causing single-digit losses to CSHI and leading to underperformance relative to T-bills. Such a scenario has yet to occur, at least since CSHI’s inception. The closest situation was September 2022, during which the S&P 500 dropped 9.9%:

And CSHI matched the performance of T-bills, with higher volatility:

Higher, longer-lasting S&P 500 drawdowns would almost certainly have led CSHI to underperform during the time period above.

On net, the strategy seems reasonable enough, although I am somewhat apprehensive about strategies in which gains are small but consistent, and risks larger, but rarer. Another Seeking Alpha author said investing in CSHI was equivalent to picking nickels in front of a steamroller. I would not characterize 4.4% in potential losses as a steamroller, but the fact of the matter is CSHI should generally make reasonably good distributions with little risk and volatility, and sporadically see small, but noticeable, capital losses. The fund’s strategy is such that these sporadic losses can’t seriously jeopardize investor capital, but they might wipe out several years’ worth of option premiums and several months of distributions.

Considering the fund’s strategy and holdings, I think the risks above are minor. Nevertheless, the risks are real, and not readily apparent in the fund’s performance track-record. Risks are easy to ignore, so take care that you don’t.

CSHI versus HIGH – Quick Comparison

Finally, a quick comparison between CSHI and HIGH.

Both funds focus on T-bills, with smaller investments in equity spreads.

CSHI exclusively does S&P 500 put option spreads, while HIGH sometimes uses calls, and sometimes uses other underlyings. The characteristics, potential profits, and risk-return profiles of these options are broadly similar, however.

HIGH’s strategy is almost always more aggressive, with the fund selling more spreads, or more expensive ones. Premiums are higher, with the fund yielding 9.4% versus 6.2% for CSHI. Higher premiums have led HIGH to outperform since inception.

HIGH is riskier, with higher potential drawdowns, as can be seen above. Volatility is higher as well.

There is a bit more uncertainty on HIGH as well, as the fund is more aggressive, with oscillations to its strategy and spreads. Performance is more dependent on management decisions and execution, too.

On net, I prefer HIGH, due to its higher distribution yield, stronger performance track-record, and broadly successful investment strategy. Management seems to know what they are doing and is executing quite well. HIGH is riskier, although not excessively so.

Conclusion

CSHI offers investors a good 6.2% distribution yield, with very low realized losses and volatility, but the potential for single-digit losses during a particularly severe bear market. I rate the fund a buy but do consider the (small) risks the fund is exposed to.