QYLG - QQQX: A Switch To QYLG Makes Sense

Summary

• Covered call funds have been embraced for their income potential and QQQX is no different.
• We examine the fund, the current setup and tell you why we think this fund is easy to sell.
• We also tell you why it is far harder to short.

Some setups are great to get out and move into something else. Some setups are great for shorting. Most of the time, the two are not the same. In other words panning something is not necessarily a signal to short a fund or a stock. We work through one fund as an example today and tell you why it fits the former category but not the latter.

The Fund

The Nuveen Nasdaq 100 Dynamic Overwrite Fund ( QQQX ) is one of the popular funds that uses covered calls as the primary strategy to enhance returns. Most funds similar to this were born during a time of extremely low interest rates and primarily designed to provide income to those finding it hard to obtain it elsewhere. QQQX though, was not a product of ZIRP (Zero Interest Rate Policy) and was actually founded in January 2007, a time well known for solid bond and fixed income yields.

It did aim for a strategy that looked for attractive total return with less volatility than the Nasdaq 100 Index, while providing regular distributions. To accomplish this, the fund investments were made in an almost identical manner to the Invesco QQQ ETF ( QQQ ). The income then came from the call options and the fund aimed to sell call options on 35-75% of the portfolio value. All sounded good in theory, especially when you have an index that is prized for volatility and you should be able to squeeze more joy out of options.

Holdings

QQQX's top holdings include the trillion dollar club of Apple Inc. ( AAPL ) and Microsoft Corporation ( MSFT ). Alongside that, Alphabet Inc. ( GOOG ) ( GOOGL ), Amazon.com ( AMZN ) and Nvidia Corp ( NVDA ) round out the top 5.

Together almost 45% of the fund comes from these 5 names. While we can be and have been hypercritical of this market cap weighted strategy, it is all too common these days. The fund's non-option comparative, QQQ, is not much different.

Two points to note here. The first being that QQQX holdings are as of November 30, 2022 and QQQ's holdings shown above are as of January 12, 2023. QQQX also holds far more smaller stocks outside the NASDAQ 100 universe. On last check it held 178 different names.

Options Income

QQQX uses options at the ultra short end of the curve. As anyone who has traded options for a living knows, you get the highest annualized return options if you choose near term plays. 25 days though is still a bit longer than what we have seen this fund do at times in the past.

The fund is writing a lot of weekly options and most calls are rather close to the money. You can derive that fact from the 104% number which suggests that the average strike was 4% away from the money. This strategy sets up high annualized returns on paper, and most options will have 20-70% annualized returns in this range. Of course the fund will not ever come close to making 20-70% a year, and that is because you end up paying a price for those kind of options. This can occur in two forms. The first being that you lose the upside of the index, when everything rallies rapidly. The second comes from you buying back your options or holdings at a higher price to maintain the same level of net exposure.

Fees

The fund's fees are about what you would expect for an option strategy fund to charge.

Sure, there are cheaper ones and we will look at one related choice as we get to the end.

Reasons To Sell Today

QQQX is beholden to the NASDAQ 100 and despite all the covered call selling, has pretty much matched the downtrend.

Not only has it matched the downtrend, we don't see a lot of volatility dampening effect of calls over the last two years. In downtrends you want outperformance and you want lower volatility to compensate you for the poorer returns these funds tend to give vs a direct equity exposure. And it goes without question that you give up big returns to be part of this process. You can see that in the next chart. Keep in mind those are total returns including your massive distributions.

The other fascinating reason to sell here is that this is a Closed End Fund and it is trading at an unusual and rather undeserved premium. Significant premiums are extremely rare for this fund and both recent events have marked exceptionally poor forward returns.

We have event 3 now with a 10.16% premium.

Verdict

The fund is a sell as the NASDAQ is just in the process of unwinding its bubble and you have a long, long way to go to reach normal valuations. Value is probably in its second or third innings of outperformance, though the chart below might suggest that we are actually in the first innings.

With QQQX you get half the upside and all the downside over the cycle and now it comes with the added flavor of an extra 10% premium. Unbelievable. But there will be fans of this and those fans will be "I am getting my income, I care not". Our response there would be:

1) Then you are reading the wrong author,

2) A managed withdrawal from QQQ will still do better,

3) We still have something for you.

What we have is, Nasdaq 100 Covered Call & Growth ETF ( QYLG ). That fund does the same dance as QQQX. The covered call selling is on 50% of the fund's holdings and we think longer term it will match the NAV return of QQQX.

Both come with a hefty distribution but QYLG's is smaller (6.67% on trailing 12 months vs 8.75% for QQQX). But since QYLG is an ETF, you don't get dinged the extra 10% premium.

Hence our logic here is, if you really want the covered call format and you choose to have it on the most expensive index, you might as well not pay a 10% premium. So selling QQQX and buying QYLG makes sense.

We will now briefly tell you why we would not short this .

The borrow costs here are around 7.0% and that subtracts from our returns.

In contrast the borrow fees for QQQ are just 0.3%.

That is a pretty big extra hurdle and an unnecessary one when we expect both to move down almost identically. We are currently short QQQ calls and if QQQ moves over our strike ($285) at expiration, we will be short QQQ as a hedge.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

For further details see: