2023-06-22 13:04:08 ET
Summary
- The VIX is at its lowest level since January 2020, indicating low implied volatility and modest option premium.
- I am downgrading the Global X NASDAQ 100 Covered Call ETF from a buy to a hold, as tech leadership is giving way to other sectors.
- Investors should consider reallocating to small caps, cyclical sectors, and the value sector for the second half of the year.
- Data suggest market pullbacks could be more severe following periods of bad breadth.
- QYLD's technicals and seasonal trends are bullish, however.
The VIX settled at its lowest level since January of 2020 earlier this week. Low implied volatility means option premium is modest. As we head into the sometimes-dicey third quarter, I assert that buying protection today is not a bad play given the Nasdaq 100’s strongest start to a year on record.
Back in mid-March, during the height of market fear surrounding the unknowns of what the potential systemic effects of the U.S. regional banking crisis might have been, I outlined a bullish idea on the Global X NASDAQ 100 Covered Call ETF ( QYLD ). I am now taking a more measured stance as relative strength among mega-cap tech (which dominates the Nasdaq 100) appears to be waning. Thus, I am adjusting my rating to a hold.
Nasdaq 100: Incredible YTD Performance
Zero Hedge
For background, QYLD is an investment product that aims to generate income by engaging in covered call writing . This yield-focused strategy with a nod toward lower volatility compared to owning the QQQ outright has historically yielded higher returns during periods of market volatility, as highlighted by Global X .
With a track record of paying monthly distributions since late 2013, QYLD offers yield investors a liquid product to express a bullish, though cautious, near-term market view. The fund can also be used as a long-term investment. Mechanically, QYLD sells call options on the Nasdaq 100 Index, allowing the investor to write covered calls without having to personally engage in options trading.
QYLD maintains an elevated annual net expense ratio of 0.60% and has just shy of $8 billion in assets under management as of June 21, 2023. The ETF demonstrates strong tradability, supported by its narrow 30-day median bid/ask to spread of just 0.06%. Currently, QYLD also offers an appealing distribution yield of 12.3% per Global X. Over the past year, there has been negative alpha, though: QYLD sports a total return of 13.1% while the popular Invesco QQQ ETF ( QQQ ) has surged 29.7%.
QYLD Underperforming QQQ YoY
Stockcharts.com
I assert that investors should look to own QYLD during periods of heightened implied volatility, thereby collecting a substantial amount of option premium. With the Nasdaq 100 Volatility Index (VXN) hovering near its late 2021 lows, not far from pre-pandemic figures, there is just not much juice in the volatility-selling trade for QYLD to make sense now. Moreover, trimming exposure to Nasdaq 100 equities after this year’s remarkable rally, then re-allocating to other industries, might be the right second-half play.
Nasdaq 100 VIX: Very Low Implied Volatility
TradingView
Better breadth has been an emerging trend. Therefore, rather than stick it out with Nasdaq 100 exposure, going with areas such as small caps, cyclical sectors, and the value sector could be prudent. The risk is if Tech is seen as a defensive area during market selloffs this year (should they occur).
According to Goldman Sachs , S&P 500 drawdowns are sharper in the six months following narrowing breadth episodes. The result in a bearish scenario in Q3 would be a pronounced decline in what has worked in 2023 to date. Couple lower prices and higher volatility together, and QYLD could be a bad spot to have a tactical overweight to. The upside is that going long the fund once volatility jumps results in a higher yield with a risk-reduced vehicle.
Early 2023 Weak Breadth May Portend A Sharper Correction Ahead
Goldman Sachs
Tech Leadership Slowly Giving Way to Other Sectors: YTD Sector Returns
Koyfin Charts
The Technical Take
Performing chart analysis on a covered call product with such a high yield is admittedly less useful compared to low-income producing ETPs, but we should still be mindful of the trend. Notice in the chart below that QYLD has bearish to bullish signs, so this counters my fundamental and macro-driven conservative stance outlined earlier.
The long-term 200-day moving average is flattening after a pronounced stretch of moving lower, while the short-term 50-day moving average has been recent support. What’s more, there was a bullish ‘golden cross’ in April when the 50-day crossed above the 200-day. Overall, perhaps we see a pullback to the 200-day, but I must concede that the QYLD price-only chart is encouraging after the fund bottomed out last October.
QYLD: Bullish Chart Pattern, Golden Cross
Stockcharts.com
Another bullish consideration is that QYLD seasonality is strong right now through mid-August (according to data from Equity Clock ), so I don't think an outright 'sell' is appropriate.
Another Optimistic Data Point: Bullish Seasonality Through Mid-August
Equity Clock
The Bottom Line
I am downgrading QYLD from a buy to a hold ahead of what could be a tech-led correction in Q3. As market leadership broadens and with low implied volatility on the Nasdaq 100, now’s not an ideal time to be tactically long QYLD.
For further details see:
QYLD: Tame Implied Volatility, Not Much Call-Selling Income To Collect (Rating Downgrade)