Yesterday's post about the single stock, option combo ETFs got me thinking about older options-centric funds that we've looked at over the years. I've dabbled with a couple of these but they can be tricky to own and it has been a long time since I used any in client accounts. I thought it might be useful to check in on a few to see whether they can play some sort of role and if so, what that role might be.
First let's look at the Global X NASDAQ 100 Covered Call ETF (QYLD). I wrote favorably about this one a couple of times noting the huge yield, used to be 10% now closer to a 15% trailing yield. The yield may have increased due to volatility generally being higher which pound for pound increases option premium realized from selling covered calls. Also as a theory, the top ten holdings include some more volatile names (higher premium from those) like Tesla (TSLA) and also Apple (AAPL) and Microsoft (MSFT) have both grown to double digit weightings which could nudge up the volatility also with the idea being that individual stocks are more volatile than indexes. Here's how QYLD has done for the last 5 years coming into 2022, so before the market was underway, versus the NASDAQ.
And here is 2022, the bear market.
So in terms of price, QYLD captured none of the upside of a strong 5 year period but captured 2/3 of the downside so far this year. Yahoo doesn't show total return. For the 5 year bull market you could simplistically add 10% per year or 50% total in dividends and for this year 7 or 8% (six months worth) back in which changes the numbers considerably. Is QYLD any sort of proxy for the NASDAQ 100? Interestingly, the correlation tool at etfreplay.com has QYLD and Invesco NASDAQ 100 ETF (QQQ) highly correlated and while that may be, I don't think investors can expect it to track anywhere close to the NASDAQ 100. It doesn't look like an investment grade bond proxy and I would note that on a price basis it essentially fell the same amount as the NASDAQ during the pandemic crash in March 2020. Here's something interesting though, QYLD looks a lot like iShares High Yield Bond ETF (HYLD).
A proxy for high yield bonds with maybe less credit risk in the face of some sort of future credit event? Is that what we're seeing? And if it is, is that compelling? Maybe the rest of the ETF world has already asked this question but either way, I need to think on that one.
Here are a few more symbols first for 5 years.
And YTD.
PUTW is the WisdomTree CBOE S&P 500 Put Write Strategy Fund. It sells put options on the S&P 500. Selling puts can be very dangerous when the market is at a high. As we discussed yesterday, an example of bad outcome from selling puts would be having to spend $50 share for a stock that has dropped in the open market to $15. The mechanics for index options are different, they settle in cash versus stock but when trades go against you it can be bad.
That being said, PUTW has done a fantastic job this year of buffering the downside versus the S&P 500. Better than I would have guessed without looking. I am not sure what sort of expectation anyone should have about how much it would go up in a bull market but selling puts will not track a big move up in equities. The fund brings in option premium below the market in hopes that stocks will either stay flat or go up (it wins with either scenario) allowing the puts to expire worthless. As a seller of options, you want the option you sold to expire worthless. Note that in the pandemic crash, PUTW fell just as much as the S&P 500. If you can accept that not every alt will work all the time, I would say this has exceeded expectations. It could maybe be thought of as an absolute return exposure but looking at the charts, the correlation to the S&P 500 seems to ebb and flow and I expect that in future crashes it will drop in line with the S&P 500 but probably won't bounce back as quickly. PUTW maybe snapped back half of what the S&P 500 did in March/April 2020.
PBP is the Invesco S&P 500 BuyWrite ETF. I dabbled in this one ages ago and haven't kept tabs since. Kind of like QYLD, I would hope a buywrite fund would track a little closer to the underlying index. Unlike QYLD, the dividend at only a 1.5% yield, does not make up a meaningful portion of the gap. Similar to PUTW, it didn't offer protection during the pandemic crash of 2020 but only dropping half of what the S&P 500 index has dropped in 2022 is impressive and surprises me. When you sell a covered call, there is nothing underneath to protect against the decline. Buy a stock at $50, sell a call struck at $60 for $1 in option premium and then the stock drops to $20, you still have that dollar but you'd ride the stock all the way down. Increased volatility likely brought more call premium for PBP, helping to absorb the downside.
The last fund is the Madison Claymore Covered Call & Equity Strategy Fund (MCN) which is a closed end fund. CEFconnect has MCN's yield at 10.64%. I owned this one for clients for quite a while before the financial crisis. It chugged along just fine, kicking out yield but not a big gainer by any means. The financial crisis beat it up and I sold it at some point in there.
Despite "equity strategy" in the name of the fund, I never considered it an equity proxy. That long term chart really is something for how flat it is has been. For the last ten years it's down about 13% but adding even just 6% per year back in for dividends, 60% total using simple math is a total return of 47% or 4.7% annualized which seems pretty absolute return-ish to me. All the better if MCN actually maintained the 10% the whole time. YTD down 16% is obviously a slight outperformer but not really a place to hide. Likewise in the pandemic crash in 2020, MCN dropped a couple of hundred basis points more than the S&P 500. I would consider buying this fund again after this review. The absolute return aspect is worthy of more investigation. I would need to dig in to see if I can figure out why it is down 16% this year. I wouldn't be dissuaded if it was a matter of equity beta but probably would not want to take on interest rate risk with this product. Given that MCN went up during the Taper Tantrum of 2013, I lean toward thinking it was equity beta.
I've really been on a run lately in trying to dissect some of these funds with the long term idea of seeing whether they can play a role in client portfolios. Maybe this is a pursuit of increasing the influence of 75/50 (a portfolio that captures 75% of the upside with only 50% of the downside) or making portfolios a little more capitally efficient if possible or some other outcome. Again, this is about tweaking at the margin. The nucleus of non-gameover portfolios will always be equities. They are the asset class that goes up the most, most of the time.
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