Monday, May 13, 2024

Digging Deep

On this week's ETF IQ, they had a quick segment on the YieldMax ETFs. These are the single stock, covered call ETFs that have extremely high yields that we mentioned yesterday. We've talked about these quite a few times noting that they have trouble outpacing their distributions and that the YieldMax TSLA ETF (TSLY) has already done a reverse split. I said that I'd do a quick look at how many of them are actually in positive territory on a price basis after looking at the YieldMax NVDA ETF (NVDY) which has been up 29% over the last year versus a gain of 210% for the underlying. 

Of their 24 funds, only a few have been around for a year and I also looked at funds in their second batch of funds that came out last summer.

In case the symbols aren't clear, APLY corresponds with Apple (AAPL) which is up 8% in the same time period, AMZY corresponds to Amazon (AMZN) which is up 41% since AMZY's inception, GOOY is Google (GOOG) up 29%, NFLY tracks Netflix (NFLX) which is up 40%, OARK tracks ARK Innovation ETF (ARKK) was down 17% and FBY tracks Meta (META) which was up 44%. 

The dispersion between the common and the covered call version is very wide. It's not that they are not working as intended but how they are supposed to work means they are not proxies for the common stock. I obviously don't know whether all of them will go down and then reverse split but that is very much on the table. If you bought NVDY hoping it would tread water and have a big payout, then you're pretty happy. If you thought you were buying something that would sort of track NVDA then you're pretty bummed for having chosen the right company but the wrong way to own it. 

If you've looked into any sort of covered call fund, you know the potential for the upside to be capped at the strike price of the call sold against the stock. Here are a couple of examples I found that show the underlying taking off without the covered call version. 

LQD is a widely held corporate bond ETF and LQDW tracks that fund with a covered call overlay.

IVV tracks the S&P 500, and IVVW sells options against IVV. IVVW hasn't been around very long but long enough for what you see in the chart. Again, it's not that I think the funds are malfunctioning or executing poorly, I think we're just seeing known drawbacks playing out. Hopefully the drawbacks are known to the holders of these funds anyway. 

On plenty of occasions I've said something like I think there could be a way to incorporate one of these in to a portfolio to add a few basis points of yield without completely missing normal market returns.

VOO is the Vanguard S&P 500 ETF and XYLD is the Global X S&P 500 Covered Call ETF. I chose XYLD because it has a long track record. The growth numbers assume dividends are not reinvested. The 80/20 mix compounded at 8.00% which is clearly not the CAGR of VOO by itself but pretty good for someone needing to be sort of close. 

Allocating just 20% to XYLD had the effect of more than doubling the portfolio's income in recent years versus just boosting it nicely in the early years of the backtest. 

Mixing 80/20 doesn't seem like an obviously terrible idea but going very heavy into covered call funds is probably not a great idea. Where they are selling volatility that arguably makes them an alternative strategy. We've talked about volatility as an alternative asset class/strategy which to my way of thinking makes them a complimentary exposure if anything, certainly not a core exposure. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.


Gregory Becker said...

I get the selling volatility aspect. If I understand it correctly you would be increasing your return in all markets except rapid increasing markets (where you would cap your return). But why does anyone seek income explicitly? Why not show returns of reinvested funds? Is this just a behavioral thing?

Roger Nusbaum said...

Hi Greg,

The typical "sell monthly calls just out of the money" hasn't increased returns in all markets except rapidly increasing. Sticking with XYLD, total return (so including divs) has compounded at 6.93% versus 13.12% for SPY since XYLD's inception. Since JEPI's inceptions, its total return has compounded at 11.66% versus 15.40% for SPY keeping in mind that JEPI's result includes a fantastic 2022. Data from Portfoliovisualizer.

Maybe the 0dte will offer more upcapture than the older ones targeting monthlies, but that remains to be seen.

skip said...

There is a big difference between selling at-the-money and out-of-the-money calls. Further, on OTM calls, how far the strike price is from the market price at the time of the call matters.

I'd not go anywhere near yieldmax or Global X or Defiance

Roger Nusbaum said...

"There is a big difference between selling at-the-money and out-of-the-money calls."


Gregory Becker said...

1) But why does anyone want income vs total return? Is it just a behavioral thing (e.g. "free money" like dividends)?

2) I'm not talking about a specific ticker's strategy. For example, say i sell OTM calls at a strike price 15% above current price and keep rolling x months every time after expiry. We go y years and the strike is never hit before expiry. The premium should increase total return as the seller has the premiums paid and the underlying. If the next 3 months, after some good news for the market the calls sold are exercised, they'd be underperforming in that time period vs the underlying. Right?

I guess what I'm getting at is that selling volatility is a way to diversify risk and get paid for that premia. And in that case I get as a way to diversify a portfolio than just market beta. I just don't get why people seem to see it as special because it's marked as income?

Roger Nusbaum said...


There's pretty much an entire "religion" built on dividend investing. Seeking Alpha has a lot of that content.

Your second point, maybe. I wouldn't anchor to a fixed percentage out of the money if you want to take on a covered call overlay. Everything else being equal, the premium should increase the return, I would agree with that but I don't think the "everything else being equal" works as often as people think.

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