JEPI - JEPQ: A Quality High-Yield ETF With Prospects For Notable Upside

Summary

• JEPQ presents retirees and investors alike with the best of both worlds.
• The NASDAQ 100 equity and covered call ETF is designed to provide high income with the opportunity for capital appreciation.
• The ETF has just bounced off the lows and fulfilled a multiple bottom trend reversal pattern. This vastly improves the margin of safety.
• What's more, the NASDAQ's reaction, the Fed announcement Wednesday bodes well for the security.

JPMorgan Nasdaq Equity Premium Income ETF Buy Thesis

I bought a 2% position in the JPMorgan Nasdaq Equity Premium Income ETF ( JEPQ ) for my Seeking Alpha Marketplace Service's Quality High Yield Income Portfolio which currently yields 12.3% with 2% in capital gains.

WWI Quality High-Yield Income Portfolio

The service is intended for retirees and income investors alike who are looking for high-yield income coupled with the opportunity for capital appreciation. JEPQ fits the objective of the service perfectly. Here is why.

JEPQ Overview

The ETF's inception date is 5/3/22. It is still in its infancy at just 7 months old. The ETF is currently 16% off its 52 week highs.

Nevertheless, it is up 6% over the past month. What's more, it just fulfilled a multiple bottom reversal pattern and broke through strong resistance at the top of the downtrend channel. 2023 looks to be shaping up well for the ETF, and market participants are seemingly taking notice by buying up shares at the lows. Let's drill down a bit and review the fact sheet.

Fact Sheet

The current expenses are 0.35%. The ETF is trading essentially on par with its NAV.

NAV vs. Market Price

Actively traded ETFs' NAV and market price are always highly correlated. They are not like BDCs and CEFs which can trade for a wide range higher or lower than their NAVs. Now let's look into why the 30-day SEC yield is much higher than the current yield stated by Seeking Alpha of 9%.

30-day SEC Yield of 17.63% Explained

I found a great definition on Investopedia that explains in detail the 30-day SEC yield calculation. According to Investopedia:

"The SEC yield is used to compare bond funds because it captures the effective rate of interest an investor may receive in the future. It is widely considered a good way to compare mutual funds or exchange-traded funds (ETFs) because this yield measure is generally very consistent from month to month. The resulting yield calculation shows investors what they would earn in yield over the course of a 12-month period if the fund continued earning the same rate for the rest of the year. It is mandatory for funds to calculate this yield. This yield differs from the Distribution Yield, which is typically displayed on a bond's website."

So the 30-day SEC yield is a forward looking yield calculation while the 9% is trailing. So I believe it presents a more accurate estimation on what to expect. Now let's dig a little deeper into the methodology behind the ETF.

JEPQ Overview

This is a monthly paying well diversified equity covered-call ETF that has some solid holdings focused on the QQQs. Furthermore, the ETFs employs a covered call options strategy through the use of ELNs to create income. The ETF seeks to deliver a significant portion of the returns as the QQQs with less volatility by the use of a covered-call options overlay strategy.

Investment Process

JEPQ basically uses the same investment strategy as JPMorgan Equity Premium Income ETF (JEPI). The major difference is JEPQ's managers invest primarily in Nasdaq 100 securities. JEPQ is an actively managed ETF. It has three managers overseeing the various aspects of the portfolio.

Portfolio Managers

On top of investing directly into the securities, the ETF sells call options through equity-linked notes (ELNs) to generate income. This is how the fund attempts to provide substantial income and also the prospect for capital appreciation.

Understanding Equity-Linked Notes

I found this great explanation of Equity-linked notes on Investopedia .

"Equity-linked notes provide a way for investors to protect their capital while also getting the potential for an above-average return compared to regular bonds. In theory, the upside potential for returns in an equity-linked note is unlimited, whereas the downside risk is capped. Even in the worst-case scenario, most equity-linked notes offer full principal protection. That is what makes this type of a structured product appealing to risk-averse investors who nevertheless have a bullish outlook on the market. That said, equity-linked notes only pay on maturity, so there is an opportunity cost for locking in that money if only the principal is returned in the end."

One important facet regarding the income derived from covered-call ELNs is the fact these are taxed as ordinary income. JEPQ may be best held in a tax advantaged account, just FYI. I am not a tax expert so please consult your accountant for specific tax advice. Below is a graphic explaining JEPQ's role in a portfolio.

Role In Portfolio

Another great aspect of owning JEPQ is the fact it is highly diversified. The ETF provides a great vehicle for gaining diversity in one fell swoop. Let's take a look at the top ten holdings.

Top Ten Holdings

I like the fact that many of the holdings in our Quality Growth portfolio are in the top five holdings of JEPQ.

WWI Quality Growth Portfolio

It makes me feel like we are on the right track having these professional managers selecting the same stocks as the service. Further, with JEPQ's covered call strategy, it provides some downside protection for our positions as well. Meta ( META ) is actually one of our holdings that is currently up an additional 20% in after hours at the time of this writing which is not reflected in the current chart. Now let's have a look at the sector exposure.

Sector Exposure

With the fund investing primarily in NASDAQ 100 stocks, it's no surprise that it is heavily weighted to the tech sector. The tech sector has definitely been the most beat up over the past year. The Fed raising rates at the fastest pace in history has inflicted sever damage to the tech sector with many stocks down 50-75%. Yet, the NASDAQ was the big winner today on the heels of the Fed decision announcement. It appears the tide may be turning.

The NASDAQ was up 2% in regular trading today. What's more, the NASDAQ 100 futures are trading higher led by META's after hours gains on stronger than anticipated earnings.

Moreover, I believe 2023 is going to be a completely different story than 2022. This should bode well for tech stocks in general. Let's now take a look at the dividend statistics.

Dividend Summary

We are set to receive our first payment of $0.58 on 1/4/23. The ETF pays monthly. The fact the SEC yield is 17% bodes well for an increasing payout. The latest run in tech stocks over the past month has increased the value of JEPQ's underlying assets substantially. The dividend has been fairly stable over the past 6 months. See schedule below.

Dividend Schedule

The dividend payouts have been fairly stable to date. Keep in mind JEPQ has only been around for 7 months. We don't have a lot of history to put our faith into. This does increase the risk profile. Even so, I like the way 2023 is setting up for the underlying assets. Now let's wrap this up.

The Wrap Up

I believe JEPQ and JEPI are both great additions to our Quality High-Yield Income Portfolio. I like the instant diversification they provide to the portfolio. On top of this, the covered-call ELN options strategy provides an income component to the equation that is hard to beat. I believe the Fed is very close to pausing its rate hikes. This should be a major tailwind for the assets held by JEPQ. Furthermore, when the Fed finally announces they see light at the end of the tunnel, most likely around May, I think JEPQ will really take off.

Let's review the facts once more. The ETF has just fulfilled a multiple bottom trend reversal pattern. This provides strong downside protection. Further, the ETF just broke through major resistance at the top of the downtrend channel. This vastly increases the margin of safety as well. Once a stock breaks through a major resistance level, that resistance now becomes support. Finally, the income provided by the potential 17% 30-day SEC yield coupled with the opportunity for capital appreciation is hard to pass up. My 12 month price target is $50 which implies 17% upside potential. I see major support at $41 and my "Buy Up To" price is $45. Nevertheless, I want to remind readers that this is only a 2% position in our portfolio. No investment comes without risks. I recommend anyone considering buying JEPQ read the ETF's Summary Prospectus which goes into detail regarding the potential risks. You can read it by clicking here . Those are my thoughts on the matter. I look forward to reading yours.

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