gopixa
Finding stable income without taking excessive risk has been hard over much of the last decade. With interest rates at historic lows for much of this time, a number of creative investments have come to market to try to offer investors inflation-adjusted income.
One new ETF that recently was indexed in September of 2023 is the Defiance Nasdaq 100 Enhanced Options Income Exchange Traded Fund (NASDAQ:QQQY). This investment makes monthly payouts by selling slightly out-of-the-money puts that are covered by an equity investment in the Nasdaq 100 and investing in U.S. Treasuries generally yielding just at or below 1%. QQQY sells put options that are at the money or up to 5% in the money.
Since the fund’s inception nearly 7 months ago, this ETF has offered total returns of 11.37%, while the Nasdaq 100 index that this fund invests in is up 19.65% as measured by total returns during this same timeframe.
I am rating this fund a buy today. This ETF uses a strategy that should be able to generate better income than most covered call investment funds since the fund focuses on selling out-of-the-money options, and also because put options generally have slightly higher implied volatility levels. This investment should also perform best in a range-bound market when volatility levels are above normal, which is likely to be the environment we see in the indexes this year.
The QQQY fund has an expense ratio of .99%, $276.40 million in assets under management, and a listed trailing yield of 38.25%. The trailing yield is misleading for several reasons. The fund has only been listed for seven months, and the total returns during this time are 11.37%. The monthly and annual payouts will also vary based on market conditions, since the daily options this fund sells have volatility premiums that will fluctuate. Most of the income from this fund is also taxed at ordinary income levels, which is different than many covered call funds, which usually enable investors to report nearly half the income as long-term capital gains.
The main reason this fund has offered investors total returns of 11.37% over the last 7 months despite paying impressive income is because of the net asset value decay. The NAV of this fund is down nearly 20% since the fund’s inception in September, and this sell-off has occurred in a generally upmarket.
A Chart showing QQQY’s details (defianceetfs.com/qqqy/)
The ETF has also paid out $6.19 of income since October of last year. QQQY has paid out nearly $.884 cents a month since September, or nearly 4.5% a month in payouts. That number is obviously not indicative of the total return an investor will get because of the inevitable decay in NAV.
A Chart showing QQQY’s recent Distributions (defianceetfs.com/qqqy/)
The weakness of funds that sell covered calls or in-the-money puts, such as this fund, is that these investments have unlimited downside while selling off the upside benefits with the strategy these ETFs use. The ideal market environment for funds such as QQQY is when the market is range-bound and volatility levels are slightly elevated, since the options premiums are higher than normal, but risks to capital preservation remain minimal. With economic growth expectations for this year remain muted at 1.5% and a major Presidential election in November, volatility levels should remain elevated for some time. Still, recent economic data suggests the US economy is likely to avoid a deeper and prolonged recession, since consumer spending levels remain healthy and unemployment rates are still low. These are the kind of economic conditions when market volatility levels should be elevated, yet equities should remain fairly range-bound as well.
Most investors in funds such as QQQY are primarily focused on income, and since put options tend to have higher volatility premiums than call options, this fund should be able to outperform covered call funds such as QYLD, an ETF that primarily sells call options that are at-the-money. QYLD has offered investors total returns of 10.47%, which trails QQQY’s performance during this same time frame by just under 1%. Most of the income paid out by both QYLD and QQQY is taxed as ordinary income.
All investments have risks, and this ETF is geared toward individuals who are more comfortable with higher-than-average risk tolerance. QQQY sells put options that are very close to the money, so investors in this ETF capture a very small amount of the upside in this investment when the fund goes up, but the downside risks remain unlimited. This investment will also perform best when the market is volatile and the implied volatility premiums in the put options QQQY sells are elevated. The primary difference between this fund and many traditional covered call funds on the market is that this ETF gets more income from a slightly higher risk strategy of selling options, and offers investors less upside returns from the underlying assets the fund is holding than some more traditional covered call funds. QQQY’s goal is to be able to return pay at least .25% of income per day to investors.
QQQY is one of the first funds to focus on selling put options rather than calls to generate income, but the core idea of this fund is not new, covered call funds have become increasingly prevalent in the market over the last 10 years. While this fund will be for investors comfortable with an above-average risk profile, this ETF should offer solid and consistent income in the current market condition for some time.
