QQQX - QQQX: Time To Rotate If Bullish Tech

2023-07-27 13:37:19 ET

Summary

• Covered call overlays tend to do better in volatile down markets, and lag in bull markets.
• A majority of Nuveen NASDAQ 100 Dynamic Overwrite Fund's composition belongs to either the tech sector or communication services.
• It might make sense to rotate to Nuveen NASDAQ 100 Dynamic Overwrite Fund for the relative downside protection.

Truth is the best defense. - Ward Churchill

A product of Nuveen, Nuveen NASDAQ 100 Dynamic Overwrite Fund (QQQX) operates as a closed-end fund ("CEF") that provides exposure to the popular tech-heavy NASDAQ 100 Index (NDX, QQQ ) while implementing a covered call strategy. By selling call options against a percentage of the fund's asset base, QQQX offers a combination of growth, high yield, and risk mitigation.

Covered call overlays tend to do better in volatile down markets, and lag in bull markets. We can see that when we look at QQQX relative to QQQ. This may be exactly why this is a time to consider rotating here.

A majority of the fund's composition belongs to either the tech sector or communication services. However, it also includes a mix of healthcare companies, biotechs, industrials, and other sectors. The fund is essentially an index fund with a covered call strategy overlay. Broad NASDAQ 100 options contracts are used for the option overlay strategy, ruling out the possibility of cherry-picking individual stocks that might present particular value.

The Overwrite Strategy

QQQX aims to sell call options on 35-75% of the value of the fund, with an average coverage of around 55% under normal conditions. The call options typically have an expiration date of one month or less into the future. They usually expire at the upcoming month-end and get rolled over to a new series of one-month options when the existing ones expire.

One crucial factor contributing to this risk profile is the discount/premium to NAV feature inherent to closed-end funds. The fund historically has traded pretty tightly, which is a positive for those looking for reliability within the constrained closed-end structure.

Delving Into The Distribution Policy

QQQX has a managed distribution policy with flexibility, meaning that the quarterly distribution can and does fluctuate over time, generally staying within a narrow range. The fund's distribution policy execution has been consistent, making it easier for shareholders to set expectations going forward. However, it's worth noting that QQQX has a history of adjusting its distributions based on economic and market conditions.

Weighing The Pros And Cons

Like any investment, QQQX comes with its own set of advantages and disadvantages.

Advantages

• Consistent Distribution Policy: QQQX has a long pattern of consistency with its distribution policy execution, making it highly sustainable and somewhat predictable for shareholders.
• Tech Sector Exposure: The fund's heavy tech sector exposure combined with a high yield can be attractive for those who want both high yield and growth in their portfolio.

Disadvantages

• Downside Risk: As a closed-end fund, it's always possible it trades at large premiums/discounts.
• Underperformance: Covered call strategies often underperform during bull markets, and QQQX is no exception.

Conclusion: Is QQQX A Good Bet?

QQQX offers a unique investment opportunity, combining the robust growth potential of the tech sector with the high yield of a covered call strategy. However, it's essential to understand that covered call strategies aren't necessarily the best as a long-term holding, since they underperform during rising markets.

This may actually be its most important feature now. If you are bullish on QQQ but are nervous about the speed of the gains achieved this year, it might make sense to rotate to QQQX for the relative downside protection. I suspect a period of outperformance is near because of that.

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