Incendiary Capital Management

Defiance ETFs has issued derivative income funds using at least four different strategies. One that I had not heard of was Lightning Spread. There's one fund with the strategy currently, the Defiance NASDAQ 100 LightningSpread Income ETF (QLDY). ETF Hearsay Tweeted that Defiance has filed for 18 more targeting some individual stocks, a couple of cryptos and a few themes. 

The big idea is going long with deep in the money calls and then selling 0dte put spreads for income with the intention of paying two times per week. QLDY started trading in mid-September and has paid out just over $3 in distributions versus its starting point price at about $50, so 6% in two months which extrapolates to 36% per year. Grain of salt on the 36% of course. 

The boilerplate on the fund page is very clear about erosion and the other obstacles these types of funds have. Somewhere in the Tuttle universe are funds that sell put spreads, notably on Bitcoin. Part of the pitch is that by selling put spreads, the upside isn't being capped like with covered calls. That might be true under the hood but QLDY is going have a hard time overcoming the very high distribution rate whether it is anywhere close to 36% or not. Here's the price only for just the two months it's been out.

We built this sort of thing many times before.

The blend "yields" about 5% and as the QLDY page notes, there will be a lot of return of capital so it very well could be tax efficient. The 70% in QQQ can be rebalanced into QLDY as its price erodes which it will do. QQQ has compounded at just over 10% per year which I believe can more than offset QLDY's erosion based on how I weighted QLDY in the portfolios. The only realistic way QLDY goes to zero would be some sort of malfunction in the realm of being a black swan, QQQ isn't going zero. Like we've said before, the likeliest outcome is they go down a lot and then reverse split like we've seen others do. The more volatile the underlying the quicker it's likely to need to reverse split (think Strategy, Tesla and Bitcoin). While QQQ won't go to zero, who knows about things like Strategy?

As I was working on this post I saw a Tweet from YieldMax about their funds reverse splitting as apparently there are quite a few coming up. The comments are incendiary. People are pissed. I'm pretty sure this is all about incorrect expectations. When I first wrote about them three years ago, I did not realize they were going to "yield" 50% or more. I referred to harnessing volatility to get some basis points but it then became clear from YieldMax itself when the distributions started printing that they had no shot of keeping up with their respective reference securities. The boilerplate was clear and their social media efforts talked about reinvesting the dividends (DRIP). They don't talk about that much anymore. 

The objective with the above income strategy isn't about keeping up with QQQ or whatever the underlying is because it's not going to do that. Someone needs income and thinks this can work. My context is some sort of finite window like retired but waiting to take Social Security or waiting to take IRA distributions If there is growth that outpaces the erosion of the slice allocated to the crazy high yielder and the overall return stays ahead of inflation, then I'd say it's working. Maybe not optimal, depending on how it plays out, that's unknowable going in, but working.

I had an additional thought on how to frame ever owning a crazy high yielder in the context laid out in the above paragraph. What might last longer, leaving the account in cash and just withdrawing until it's gone or some sort of higher "yielding" blend? If you avoid crazy CEO risk and avoid crypto volatility, plenty of the crazy high yielders avoid those risks, then something like Portfolios 2 and 3 can sustain for that finite window we talked about. It won't keep up, but that's not the objective. Repeating for emphasis, keeping up is not the objective. The objective is sustaining for some finite period of time. 

If you're 30 or 40 and still accumulating, I don't know why you'd ever buy a crazy high yielder. 

I haven't done anything remotely close to this for any clients but it's interesting theoretically. I would take these posts as being about exploration and theory that maybe becomes useful a couple of iterations down the road. If anything like this could ever make sense, I suspect it would have to do with selling puts not selling calls. 

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