Dividend Mockery

The Barron's Streetwise column made fun of Nvidia (NVDA) for only paying a one cent quarterly dividend. With the stock at $180, four cents a year yields nothing. One of the comments mentioned that it probably pays the penny so it can be included in dividend indexes. I'm pretty sure I've seen it included in a couple of dividend funds. 

We've had a lot of fun looking at the various crazy high yielding, derivative income funds. As I look at the YieldMax website, it says the "yield" for the NVDA YieldMax ETF (NVDY) is 52%. The distribution rate for all of these can be a bit of a moving target but these fund have had very high distribution rates.

The distributions are so high that there's pretty much no way that these products can keep up with their respective reference securities. We've described the crazy high yielders as being products that sell the volatility of their reference securities, not proxies for their reference securities. More precisely, they combine the reference security plus the selling of volatility which gives a much different result than just holding onto the common. 

Before the crazy high yielders existed, there were people trying to sell 3% per month covered call programs and every one that I ever looked at ended in tears. In blogging about those, I would typically say to frame it in terms of trying to squeeze out a fifth dividend by selling call options so if you think about it, the goal would be an extra 1-2% per year as opposed to 30%.

Selling calls far out of the money on Nvidia might create a version of manufacturing a humble dividend that doesn't necessarily prevent any and all upcapture. With the common at $180, the 220 call, expiring on December 26 was bid at $0.85 on Friday. Simplistically extrapolating $0.85 for a call about 20% out of the money every month would be $10.20 annually which would be a 5.6% "yield." 

The strategy would result in assignment (having to sell the stock at the strike price) only after a 20% gain in a single month. Is that something that happens very often, 20% in a month sounds like a big move? According to Copilot, over the last 12 months, it would have happened three times which is surprising. Selling options 25% out of the money would have also resulted in being assigned in those same three months but the options premium would have been significantly less than $0.85 per month. 

Does this approach make any sense? With a little flexibility, maybe so. The three months where the stock moved up more than 20% were around the time of the tariff panic when the common fell by about 1/3. Looking at the 21st century, Copilot says there have been 35-40 individual months where the common stock gained 20% or more so a little more than 10% of the time. Maybe tweak the strategy if the market just cratered by skipping a month or going 30% out of the money. If the stock just fell 30% in a fast panic, there's a decent chance the premiums up and down the chain would be elevated. 

Pulling this off would take a lot of time and selectivity but I don't think it's obviously terrible on its face. There is the opportunity to get a lot of upcapture from the common as opposed to NVDY where that is not the case. But then the trade off is how much in actual dollars will be made versus the time spent? Would you be willing to turn managing your portfolio into a full time job for an extra $20,000/yr? How about a 20 hour/week job for that extra $20,000? The trade off might not be worth it and while 20 hours/week is probably an exaggeration relative to selling calls on one stock position, you can see where there is a pivot point where the extra work doesn't justify the extra return, assuming it's even successful which might be a big if.

And a quick hit on a different type of option strategy.

The dark green line is the Vanguard S&P 500 ETF (VOO). Of the other three, one is a fixed income fund with very little volatility and the other two use equity options that try to create a result that looks nothing like the equity market. 

The two options based funds fall in the realm of defined outcome/buffer and I am warming up to them. Once you embrace that they are not equity proxies and figure out what should they do it becomes easier to assess them accurately. Do you have a reasonable basis to believe they can do what they intend to do? In the period studied there was a short-ish bear market and a full on panic. There are some squiggles along the way but they've been doing what they say they're going to do. 

There are complexities here because at some point of a large decline, they will start to look like equities. Down 20% in a calendar quarter is a common point where the option strategy stops offering protection so if these interest you even a little bit, fine but they should not be more than a small slice and if the market comes close to breaching the buffer, it might make sense to sell and let it reset for the next period whether that is a quarter or some other time frame. 

The utility is fixed income-like without actually being fixed income which I think is pretty important when sized appropriately. 

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.