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Finding stable and significant income investments in the market has become much more challenging. With rates higher, leveraged funds performing worse, and higher prices requiring more income to for many to cover monthly expenses, many dividend investors are struggling.
An investment that has become more common place for income and dividend investors to turn to in this more challenging environment are covered call strategies. One more well-known ETF that focuses on selling covered calls is the Global X NASDAQ 100 Covered Call ETF (NASDAQ:QYLD).
QYLD has offered investors total returns of 102.94% over the last decade, while the S&P 500 (SPY) has offered investors total returns of 180% during the same time period. Still, QYLD is an income fund that is focused on offering investors solid and consistent income, this ETF is not built on maximizing total returns.
I last wrote about QYLD in August of last year. I rated the fund a hold since I correctly thought that lower general levels of volatility in the market would lead to lower income payouts. I am upgrading my rating of this investment to a buy today for several reasons. First, volatility levels should rise for multiple reasons, and the VIX is at the low end of the range this measuring tool usually trades at. Second, growth estimates for this year remain tepid, the market is likely to remain rangebound for some time. Finally, this fund’s heavy focus on large-cap technology stocks should keep this ETF from being excessively volatile even if economic and market conditions deteriorate more.
QYLD has an expense ratio of .61%, $8.8 billion in assets under management, and a trailing yield of 11.50%. This ETF has holding that 51.58% in the technology sector, 15.49% in the communication sector, 12.74% in consumer cyclicals, 6.48% in consumer defensives, 6.46% in health care, 4.84% in industrials, 1.22% in utilities, .47% in energy, .46% in financials, and .26% in real estate. QYLD’s largest holdings are Microsoft (MSFT), Apple (AAPL), NVIDIA (NVDA) and Amazon (AMZN). These four positions make up 28% of the fund’s overall holdings.
The fund makes monthly payouts. QYLD uses as a strategy of selling at-the-money monthly call options against the Nasdaq 100 that the fund owns. The ETF then distributes the monthly payouts as income to investors. This fund uses the same strategy each month regardless of market conditions. The income generated from selling the options is taxed at 60% capital gains, and 40% as short-term gains.
QYLD performs best in a market where volatility levels are elevated so the volatility premiums of the options the fund sells are higher, but the market is not so volatile that the fund’s possible losses are excessive. The strategy this ETF uses limits upside potential, so in a market with very high levels of volatility this fund can face unlimited loss potential while the investment’s upside is capped.
A Chart of QYLD’s Payouts (Seeking Alpha)
QYLD has paid out steady income since the fund’s inception in 2014. Even though payouts were slightly lower in 2023 primarily because volatility levels dropped in the back half of the year, the fund still paid out $2.06 over the last year, or 11.50%.
A chart of the VIX (The Chicago Board of Options)
The primary factor that affects the monthly distributions QYLD makes is the volatility premiums in the monthly options that this fund sells against the core holdings. Even though the VIX is trading at the lower end of the 10-year range this index has seen, there are multiple reasons to think that volatility levels will be higher throughout this year.
The market will likely face both political uncertainty and economic uncertainty in 2024, and tensions globally continue to be high in the Middle East and with the war between Russia and Ukraine. Economists are also forecasting 2024 to be a slow growth year. Economists are still predicting 2024 to be a slow growth time. The Fed also likely won’t want to be seen as interfering in the election, and prices remain high even though the rate of inflation has moderated to nearly 3%. The market is likely to remain rangebound over the year with earnings and growth estimates so conservative, and volatility levels should also rise from the current lower range.
All investments have risk, and this fund does cap upside potential while not limiting potential downside losses. Still, QYLD’s beta is fairly conservative. This fund has a beta of .63 compared to the S&P 500, and .53 compared to the Nasdaq 100 index this ETF holds. QYLD offers investors more steady income than other covered calls funds such as the JPMorgan Premium Income ETF (JEPI) since this ETF uses the same strategy of selling at-the-money monthly calls each month, while funds such as JEPI are selling options differently each month at the discretion of the managers of the fund. This fund also limits upside more but also generates more income from the options being sold than alternative investments that sell out-of-the-money call options.
Covered call funds perform best when volatility levels are elevated but downside risks are not excessive, and these are the market conditions that the market will likely see over the next year. QYLD is also uniquely well-positioned to outperform the broad indexes if the market is rangebound, because of the income this investment generates from monthly options. While the strategy that this ETF uses limits upside potential, QYLD’s strategy of selling at-the-money monthly calls every month will also appeal to income investors who are looking for steady payouts.
