SPY - QQQX And SPXX: Pair Of Overvalued Option Income CEFs Ready To Revert

Summary

• QQQX and SPXX are equity option income CEFs.
• QQQX and SPXX are overvalued relative to their recent history.
• Alternatives for each fund are suggested.

Author's note: This article was released to CEF/ETF Income Laboratory members as part of the CEF Weekly Roundup. Please check the latest data before investing.

Nuveen Nasdaq 100 Dynamic Overwrite Fund ( QQQX ) and Nuveen S&P 500 Dynamic Overwrite Fund ( SPXX ) are popular equity option income CEFs. They invest in the underlying stocks of the NASDAQ-100 ( QQQ ) and S&P 500 ( SPY ), respectively, but write call options on around 55% of their portfolio (with a dynamic 35%-75% range), making them more defensive and less volatile than the underlying indices. QQQX and SPXX would be expected to outperform QQQ and SPY in flat or declining markets, but underperform in rising markets.

We can see this defensiveness in action this year. QQQX has returned -27.88% YTD at a total return NAV level compared to -32.81% for QQQ, while SPXX has returned -16.16% on a total return NAV level compared to -20.10% for SPY.

However, on a total return price level, the differences are even more stark. Here, SPXX (-7.70% YTD) outperforms SPY by 13 percentage points, while QQQX (-25.02% YTD) outperforms QQQ by over 9 percentage points.

Experienced CEF investors will know that the discrepancies between total price and total NAV returns are due to premium/discount fluctuations. The divergence between price and NAV has widened dramatically for both funds over the last two months.

As a result, QQQX and SPXX have reached 52-week high premiums of +9.38% and +10.39%, respectively, which are in fact the most expensive that these funds have been since 2018. It's interesting that the premiums have risen so quickly over the past several months; possibly, investors might be looking at the price of the funds only and not realizing that the NAVs have fallen amidst the ongoing bear market. The rapid rise in premiums means that QQQX and SPXX currently sport 1-year z-scores of +3.1 and +2.6, respectively, indicating significant overvaluation relative to its historical average.

While premiums can always go higher for various reasons, I don't see any fundamental reason why QQQX and SPXX should trade at such valuations. There are many other equity CEFs or ETFs employing option income strategies, so the two funds are hardly unique in this regard.

Hence, this would be a good chance for owners of QQQX and SPXX to harvest this premium and rotate into other less overvalued CEFs. An ETF alternative for QQQ would be a combination of QQQ (0% option coverage) and Global X NASDAQ 100 Covered Call ETF ( QYLD ) (100% option coverage), to mimic the ~55% option coverage of QQQ. Similarly, QQQX might be conceivable replaced with a mixture of SPY (0% option income coverage) and Global X S&P 500 Covered Call ETF ( XYLD ) (100% option coverage).

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