QYLG - GPIQ And GPIX: Goldman Sachs' Response To JEPI And JEPQ

2023-11-30 02:59:08 ET

Summary

• Goldman Sachs has launched two covered call funds, GPIX and GPIQ, as direct competition to JPMorgan's highly popular funds JEPI and JEPQ.
• These funds write covered calls partially against their portfolio holdings (25% to 75%), allowing them to participate in some market upside.
• The funds will use FLEX Options instead of ELNs for premiums, offering price stability and negotiation flexibility.

JPMorgan's two covered calls funds JPMorgan Equity Premium Income ETF ( JEPI ) and JPMorgan Nasdaq Equity Premium Income ETF ( JEPQ ) became two of the biggest covered call funds in the market with combined AUMs of almost $40 billion. It was only a matter of time before Goldman Sachs ( GS ) would join the game with its own versions of these funds and it looks like those funds are now out. Goldman Sachs S&P 500 Core Premium Income ETF ( GPIX ) and Goldman Sachs Nasdaq-100 Core Premium Income ETF ( GPIQ ) are two funds that are launched as direct competition against JEPI and JEPQ. In this article, we will review these two funds.

The two funds (GPIX and GPIQ) have very similar methodologies, approaches and philosophies with the only difference being that GPIX covers the S&P 500 index and GPIQ covers the Nasdaq index so GPIQ is the technology oriented version of the two.

One thing that separates these funds from JPMorgan's funds is that they are writing covered calls not in full but partially against their portfolio holdings which means these funds will be able to participate in some of the upside in the markets. Below quote is from the fund's prospectus:

The overwrite level (i.e., the ratio of the notional value of call options sold by the Fund to the market value of the equity investments in the Fund’s portfolio) is generally revised each month and the Fund expects that, under normal circumstances, it will sell call options in an amount that is between 25% and 75% of the value of the equity investments in the Fund’s portfolio.

So the amount of calls the fund sells against its positions can range from 25% to 75% with mid-point being 50%. This reminds me of another fund that uses a very similar approach which is Nuveen NASDAQ 100 Dynamic Overwrite Fund ( QQQX ). That particular fund determines how many options contracts to write based on where VIX is because it will determine how much premium it can harvest. I can expect GPIX/GPIQ to follow a similar approach and determine the number of option contract sales by volatility numbers at any given day.

Since these funds are writing fewer contracts as opposed to JPMorgan funds which write calls against 100% of their positions at all times, we can expect them to have a smaller dividend yield but also be able to participate in more upside of the market. After all, this is all a trade-off. If a fund is writing calls against 25% of its holdings, it will generate 1/4th of the covered call premium yield but be able to participate in 75% of the upside. If a fund writes calls against 75% of its portfolio, it will generate a much higher dividend yield but have a much smaller upside potential.

Just to illustrate this point, you can see a chart below comparing two funds of the same company Global X. One of these funds is QYLD ( QYLD ) which writes monthly covered calls against QQQ using 100% of its positions and generates a yield of 12% and doesn't participate in any upside. The second fund is QYLG ( QYLG ) of the same fund management company, which writes calls against only 50% of its position, having a dividend yield of 6% and participating in half of the upside. As you can see below, the second fund outperformed the first one in total returns even though it had a much smaller dividend yield.

Of course this doesn't mean it will be always the case. QYLG would have underperformed in 2022 when Nasdaq was in a bear market and QYLD was able to soften the blow by collecting call premiums. When the market is declining or staying flat, selling more options could be more lucrative as opposed to selling fewer options. Also, when overall volatility and VIX is higher, it may be more profitable to sell as many options as possible as compared to when VIX is low. Currently we are near the bottom of the 3-year volatility cycle for both S&P 500 and Nasdaq.

Unlike JEPI/JEPQ, the Goldman funds will not be utilizing ELNs for premiums. Instead it will use a vehicle called FLEX Options. These are European style options that don't convert into shares and settle at cash value so they can be easily rolled up and down forever without worrying about losing your shares. Also, FLEX Options are typically traded between institutions and their trades may not show up in a typical options chain. One advantage of using FLEX Options is that you can get a set price which is agreed upon by both parties on option contracts instead of relying on bid-ask spreads in traditional options chains. When you are buying or selling only a few options on liquid assets like SPY you might not worry too much about bid-ask spreads but it can make a big difference and even swing option prices wildly when an institution buys or sells thousands of contracts at once so it's better for them to use FLEX options for the sake of price stability. Institutions can negotiate and settle different aspects of FLEX Options such as expiration dates, strike prices, settlements and other rules and can get access to contracts that retail investors can't even see in an options chain.

Both funds will be actively managed by Goldman Sachs' subsidiary Goldman Sachs Asset Management LP and their performance will be highly dependent on the expertise of the team which manages these funds. As of the writing of this article, these funds' webpage doesn't show any holdings since they are still setting up logistics.

Both funds are up and trading though. in fact, the funds launched at the perfect time at the end of October just near the bottom of our most recent pullback which carried S&P 500 to 4100 by October 27th. Both funds luckily launched the day after the bottom and they both have been participating in this recent rally with GPIQ being up 11% and GPIX being up 9% in the last month. This tells me that these funds didn't write many options contracts yet. If they did, their upside would have been more limited. Perhaps they eventually wrote some contracts but not right away as they both seemed to be rallying relentlessly until about November 14th.

Are Goldman Sachs funds better than JPMorgan funds? Time will tell. It will also depend on what kind of market we experience in the next few years. If we have a bull market where stocks rally relentlessly, Goldman Sachs funds will probably perform better. If the market stalls or starts heading downwards, JPMorgan funds will probably do better. One could say that currently JPMorgan funds are set up for neutral conditions whereas Goldman Sachs funds are set more for bullish conditions. You can also make your decision between these funds depending on how bullish/bearish you feel towards the market. If you are undecided about whether to be bullish or bearish, you can also buy equal amount of each for the sake of diversity and see which one performs better over time.

One thing we don't know about Goldman Sachs funds is where they will set the strike price in their covered calls. JEPI and JEPQ typically write calls that are 1-2% out of money so investors get to participate at least in a small portion of the upside. Since Goldman Sachs' funds didn't publish their current holdings, we don't know where they will set their strike prices at but they will likely be close to the money since these funds will only write calls against a portion of their holdings.

These funds would be best if held in tax sheltered accounts such as a 401k portfolio because most of the income will be distributed as either ordinary income or capital gains. Funds haven't announced a target dividend yield but I expect it to be around 5-7% for GPIX and 6-8% for GPIQ depending on how many options they sell each month and where volatility is.

I am personally buying a small amount of each fund in my 401k and plan on holding for a long time to see where they go. Over time, I don't plan on adding much besides reinvestment of dividend distributions that I will be receiving from these funds.

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