SVOL - QQQY: 60-Day Check-In Gauging Performance Against Peers

2023-11-29 22:57:25 ET

Summary

• Defiance Nasdaq 100 Enhanced Options Income ETF seeks to offer investors a better risk/reward profile and access to significant monthly income.
• QQQY sells 0DTE ITM put options and secures its options with margin, allowing cash to be deployed into bonds and cash-like assets with positive yields.
• This article focuses on the fund compared to several of its peers, focusing on performance, income, and volatility.

Introduction

On 9/13/23, Defiance ETFs launched the Nasdaq 100 Enhanced Options Income ETF ( QQQY ). The premise of the fund is that selling options on QQQ instead of buying long stock offers investors a better risk/reward profile for their investment and access to significant income.

I have held off on covering this fund because it is so new, but now that we have had over two months of performance to look at, we can start to evaluate the fund.

Here is the total return so far against the underlying index, ( QQQ ).

Overview

QQQY is unique in its offering, as it seeks to sell 0DTE ITM put options. For those not in the know, this means that the fund writes options against QQQ expiring the same day they are written, and they are written at strikes that are likely to be exercised at expiration.

Because the ETF is writing options, it can secure its options with margin. This allows the cash in the portfolio to be deployed into bonds and assets with positive yields to help the overall yield.

If that didn't make enough sense, here's Defiance giving it a shot:

QQQY aims to achieve consistent and outsized monthly yield distributions for investors coupled with equity market exposure to the Nasdaq-100. QQQY is an actively managed exchange-traded fund ("ETF") that seeks enhanced income, constructed of treasuries and Nasdaq-100 index options. The strategy's objective is to generate outsized monthly distributions by selling option premium on a daily basis. The fund uses daily options to realize rapid time decay by selling in the money puts with 0DTE.

The Fund's primary investment objective is to seek current income. The Fund's secondary investment objective is to seek exposure to the performance of the Nasdaq 100 Index (the "Index") subject to a limit on potential investment gains.

Check out QQQY's current holdings here , as they change daily. Depending on when you read this, the options may look radically different.

Don't be alarmed at the written yields on the UST held in the portfolio. Because the fund was created recently, it had the luck of being able to purchase those bonds cheaply.

While those two UST notes were auctioned in December and November of 2021 respectively, they were purchased in September 2023, meaning that they were purchased at a steep discount to par, which offsets the loss of yield on older notes. This is the risk of not holding bonds till maturity. They could lose market value being sold before maturity if interest rates rise.

Here is the December issue , and here is the November issue .

Currently, the fund boasts $194M in AUM. It has seen a quick run-up and shows little sign of slowing.

The 30-day SEC Yield is 3.41% and the distribution rate is an eye-watering 65.78%. Of course, it will take time for the yield to even out, or it may never find stability. Projecting forward, we could expect the current performance to yield about 11% p.a. Distributions are made monthly.

Performance

So how has QQQY stacked up to similar ETFs?

Well, the first competitors that come to mind are:

( QQQ ) - the original NASDAQ 100 ETF, the underlying index for QQQY

( JEPQ ) - JPMorgan's Nasdaq Premium ETF, an OTM-covered call strategy

( QYLD ) - Global X's Nasdaq Premium ETF, an ATM covered call strategy

( QQQX ) - Nuveen's Dynamic Overwrite Fund, a CEF that sells calls on NDX

( SVOL ) - Simplify's Volatility Premium ETF, a fund selling VIX futures

( PUTW ) - WisdomTree's strategy of selling puts against the S&P 500

Unfortunately, there are very few funds using puts as their income vehicle of choice. Mostly, similar funds use calls in their strategy. This is likely due to easier risk management during crashes and black swan events, something that a fund like QQQY could be damaged by worse than these covered call funds.

There is an advantage to using puts, though. There is an increase in income, to compensate for the risk. We can see the general deviation in volatility between puts and calls very clearly in Figure 5, which shows the volatility skew of NDX options , with puts having a higher volatility than paired calls. This leads to puts being more expensive most of the time (bar June and part of July this year), which could lead to higher income if realized volatility is less than implied volatility.

We can take a look at several different metrics important to investors looking into QQQY to see how the competition has performed in the same time span.

Note that because QQQY is so new, I'm also going to include a chart at the end without it to show a longer history of the other funds.

In total return, since QQQY's inception, nothing has beaten the tried and true "buy and hold" QQQ, but by a very small margin. I would consider the difference here between QQQY, QQQ, JEPQ, QQQX, and SVOL to be similar enough to not be relevant here.

As far as income goes, only QQQ and QQQX are lacking in the income territory. SVOL, of course, blows the rest of the funds out of the water. It does lack the capital appreciation aspect that you might see with the other funds, but its income is something to be marveled at. If you want to read more about SVOL, I covered it recently and downgraded it to a hold . Those trends may be reversing, so those interested, please stay tuned for another follow-up by the end of the year.

Note that the other QQQ-based income funds seem to have fairly even dividend yields, meaning that we could reasonably expect QQQY's yield to even out soon.

I was not surprised by the volatility of these funds, with the beta being the largest determining factor of volatility.

The funds with the most beta (market exposure) are the most volatile. The fund with the lowest beta, SVOL, exhibits the lowest volatility.

Be careful with the color change. We can see a full one-year timespan if we exclude QQQY. This gives us a better picture of how these funds have performed overall compared to the underlying. Note that a 39% one-year return is exceptional for QQQ and should not be considered "normal."

QYLD allows us to go back about nine years. While neither of these two funds approximates QQQY's strategy, let this chart be a cautionary tale of the potential for long-term underperformance.

When I say long term, I mean long term.

We can go back as far as 2007 to see how chronic underperformance can leave investors behind.

Conclusion

QQQY offers investors an opportunity to try out a unique actively managed strategy, one that trades daily options. There are no funds that are doing the same thing, though there are many that are trying to be similar.

Unfortunately, so far, complexity has not paid off for these funds. The entire category seems to lag QQQ itself. Beta may still be king when it comes to equity investing.

While the income is welcomed by many investors, that is not the only thing investors need to worry about or concern themselves with. Lagging the index by 600% over the course of 18 years, as QQQX has, is unacceptable.

I will try to cover QQQY again in a year or so, to see how the strategy changes and evolves, as well as to be able to gauge the performance more. Until then, I have to rate the fund a hold as I don't believe we have the data to say how this investment will act and I don't see it having a place in my income portfolio currently.

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