2023-07-26 09:00:00 ET
Summary
- QYLD is an income-generating investment, not for capital appreciation, as it caps upside potential by writing covered-call contracts.
- It generates double-digit yields and provides monthly income from the premiums collected. Despite uncertainties, I believe QYLD will continue to appreciate in value.
- QYLD could be a good investment for those comfortable with sacrificing capital appreciation for income, as it has delivered 115 consecutive months of distribution to shareholders since 2014.
I am a fan of covered-call ETFs as income-generating investments, not as a vehicle seeking capital appreciation. When a covered-call contract is written, the upside potential is capped because the party purchasing the contract is paying a premium to own those shares at a specific price in the future. If generating alpha on your invested capital is the primary goal my suggestion is to look elsewhere. The Global X Nasdaq 100 Covered-Call ETF ( QYLD ) generates double-digit yields because the upside potential is capped. Investors are receiving monthly income from the premiums collected, writing covered calls against the positions in QYLDs portfolio. I hold QYLD on the income side of my portfolio, and I have been bullish on its income-generating characteristics. While QYLD won't generate the same returns as investing directly in the Invesco QQQ Trust ETF ( QQQ ) when the markets climb, it should still marginally appreciate in value. If the market continues to melt up I believe QYLD will follow to a degree while still producing large amounts of income for investors. I was bullish on the way down, and I have been bullish on the way up. Since my last article on May 23 rd , shares of QYLD have appreciated by 2.58%, and after the distribution was paid, the total return has been 3.62%. While there are still uncertainties, I believe the market will ultimately appreciate, and shares of QYLD will continue grinding higher.
When it comes to covered-call ETFs you need to understand what you're getting involved with
No matter what the investment is, you should always do your due diligence and understand the investment. Some investments, such as QYLD, are different from traditional investments, and investors should investigate the mechanics before allocating capital. The 11.78% yield is enticing, but there is a reason it's in the double-digits, and some investors may not be willing to make the sacrifices required to generate this amount of yield.
QYLD writes covered calls on its portfolio to generate the yield. In previous articles I have written about QYLD, some have called QYLD a gimmick fund because of its mechanics. QYLD isn't a gimmick, as it has $8.24 billion in net assets , but it operates much differently than traditional ETFs.
When you write a covered-call contract, you are entering into an agreement with another party to sell your shares on a certain date at a certain price. The other party pays a premium which is collected upfront for the right to purchase your shares at that pre-determined price. I will use Apple ( AAPL ) as an example to demonstrate selling a covered call.
Below is the options chain for Amazon (AMZN). I selected the September 1 st date as the expiration date. Every options contract is the equivalent of 100 shares. A call option becomes covered when you own the shares and sell a call against them.
In this example, I am using the Sep 1 st 2023 option chain with a strike price of $145. I built a calculator in Google Sheets where I can input the call information, and it will calculate my returns. Some of the most common ways investors will utilize covered calls are to generate income from investments that don't pay a dividend, set an established sell price and get paid to sell, or generate additional income from dividend-paying investments.
In this example, I am using 100 shares of AMZN which would allow someone to write 1 contract against those shares. I am selecting a $145 strike price which means that if AMZN is $145 or higher on September 1 st the person on the other end of the contract will buy my shares for $14,500, no matter how high the shares have gone. If the shares never reach $145, the contract will expire worthless, and I would keep the premium.
By writing 1 contract on AMZN on the September 1 st options chain at a $145 strike price, you would generate $170 of income as the current bid per share is $1.70. AMZN trades for $12,880, so you would generate 1.32% on your current invested capital based on AMZN's current price ($170 / $12,880). AMZN would need to appreciate by 12.58% to reach $14,500 for the contract to be executed on September 1 st . There are currently 39 days till expiration, so you would be locking up the 100 shares for 39 days. If AMZNs share price exceeds $145 on September 1 st , no matter how high it is, the contract will be executed, and your shares will be sold for $14,500. You will have made 1.32% upfront, then the profit from the capital appreciation would generate another 12.58%, placing the total profit at 13.9%. If shares never reach $145, the contract would expire worthless, and you would keep the $170 and generate 1.32% in income over 39 days from an equity that doesn't produce a dividend.
Steven Fiorillo, Seeking Alpha
I personally write covered calls and cash secured puts on some of my positions to generate additional income. QYLD does what I just explained on a much larger scale. QYLD owns the underlying assets as it invests in the companies that make up the Nasdaq 100 and then writes covered calls against those positions. Writing covered calls on its assets limits the upside potential if the market is appreciating as a trade-off to pay large amounts of income to its investors monthly. If the market rallies, the upside in QYLD is capped to an extent. Each month QYLD will write or sell one-month call options on the Nasdaq 100 index, which are covered since QYLD holds the securities underlying the options written. Each option written will generally have an exercise price at or above the prevailing market price of the Nasdaq 100 index from when it was written, creating immediate income for QYLD.
Why I like QYLD for income and feel it can keep grinding higher
I am bullish on QYLD as a component of a diversified income portfolio. I compiled each monthly distribution QYLD has generated since inception and created the table below. Since QYLD doesn't rely on dividend harvesting to generate income, it can own a larger variety of equities that may generate a small dividend or no dividend at all. Since QYLD is writing covered calls on its portfolio, it doesn't need to worry about yield farming or pay attention to which companies are cutting the dividend or not growing their dividend. The options market allows QYLD to generate income each month, no matter what the market is doing, and utilize the premiums it generates to pay the distributions to shareholders. QYLD takes the manual work out of writing covered calls and provides a product that does the work for investors.
If your ok with the fact that QYLD caps the upside potential and sacrifices capital appreciation for income, then it could be an interesting investment for you. QYLD debuted at $25 and closed at $25.04 on its first day of trading. Since January 2014, QYLD has delivered 115 consecutive months of distribution to shareholders. In this period, QYLD has generated $22.47 of income, which is 89.88% of its initial IPO price.
Some investors look at the price decline and don't feel the investment is worth it, which is fine because if you're not comfortable with an investment, then you probably shouldn't make the investment. When I see the price decline from $25 to $17.86, I look at it as an investment that has currently lost 28.60% of its initial value, but if you're collecting the income, it has generated 89.88%, which puts it at net 61.3% positive in addition to continuing to produce double-digit yields.
Global X, Steven Fiorillo
QYLD invests in companies within the Nasdaq 100, and its largest positions are Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), NVDA (NVDA), Meta Platforms (META), Tesla (TSLA), Broadcom (AVGO), Alphabet (GOOGL) (GOOG), and PepsiCo (PEP). I believe big tech is going to lead the markets higher as we're experiencing a technological revolution that could turn out to be bigger than cloud computing or the internet.
While the CME FedWatch Tool indicates a 98.9% chance we see a 25 basis point increase this week, the St. Louis Fed indicates that rates will decline to 4.6% in 2024 and 3.4% in 2025. If this occurs, the cost of capital will decline, and companies will be more likely to invest in expansion. If this occurs, I think capital will flow to the largest companies as their products and services will be needed to facilitate corporate expansion. This should positively impact EPS expansion in companies such as AAPL, MSFT, and GOOGL which should help the markets grind higher. If the markets continue to move higher than QYLD should follow to a degree while still generating large amounts of yield from their covered-call methodology.
Conclusion
From a chart perspective, QYLD hasn't been pretty, but it doesn't need to be to generate value for its investors. QYLD is constructed to sacrifice capital appreciation for immediate income paid monthly and geared toward income investors. I like owning funds that utilize covered-call strategies to generate income as I invest the distributions to increase the future income generated. If you have time on your side and are looking for monthly income, QYLD is very interesting. Please leave your comments below, and I will try to answer as many questions as I can. I feel the markets are positioned to go higher in the back half of 2023 and into 2024, and if they do, QYLD should grind higher.
For further details see:
QYLD: If The Market Melts Up, This ETF Should Continue Rebounding