XYLD - XYLD: All The Risk With Little Reward In The Form Of Income

2024-06-11 01:21:21 ET

Summary

• Global X S&P 500 Covered Call ETF has generated strong returns from option premium income, but recent changes in implied volatility and market conditions make it a risky investment.
• Collapsing implied volatility has significantly reduced the potential income returns of the XYLD, with past low volatility periods resulting in income returns of just 5-6%.
• Extreme valuations and declining market breadth also increase the risk of steep market declines, and the XYLD may not even outperform the S&P 500 during a bear market.

I last covered the XYLD in January last year, when I argued that high levels of implied volatility would allow the ETF to generate strong option income, which would likely outweigh the impact of any capital gains in the S&P 500. Since then, the XYLD has returned a decent 16%, with these returns coming almost entirely from option premium income. A lot has changed since then, however. Specifically, 1-month implied call option volatility has fallen by around a half, while the S&P 500's valuations have risen to extreme levels while market breadth has collapsed. The income that the XYLD is likely to generate is now no longer worth the risk of a large drop in the market, and any spike in volatility could actually see the ETF underperform the S&P 500 even under a declining market scenario. I am therefore shifting by recommendation from a hold to a strong sell....

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