Ben
@benjammin1234
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Covered call ETFs have grown in popularity with investors looking for yield.
Below I'm going discuss the basics of how these ETFs work, using $QYLD as an example, and some things I looked at when researching (I am long $QYLD in my Roth 401k, it's about 1-2% of my overall portfolio).
Covered call ETFs utilize a covered-call options strategy, also known as a buy-write strategy because the fund is buying the underlying stock/security and then writing call options.
With $QYLD , the fund buys stocks in the Nasdaq 100 and then sells, or writes, at-the-money calls that expire in a month and collects the option premium.
This is an income producing strategy, which shows with $QYLD having a 12-month trailing yield of around 12%. The expense ratio for the ETF comes in at 0.60%.
Anytime you get a very high yield there are going to be tradeoffs. In this case, investors are trading upside potential for income potential. This is evident if you look at the attached picture of the total return over a 1 year period in $QYLD vs. $QQQ , a Nasdaq 100 ETF. At the same time, investors are still exposed to much of the downside risk, although the monthly distribution helps offset some of this.
Tax considerations were another thing I took into account and this is part of the reason I hold $QYLD in a Roth 401k.
Here’s a breakdown from Global X on the tax structure of $QYLD ’s 2019 distributions: the Global X Nasdaq 100 Covered Call ETF made total distributions of $2.322700 per share. Of these distributions, $1.977693, or 85%, was treated as ordinary dividends/short term capital gains. $0.064376 (3%) was treated as long term capital gains. Last, $0.280631 (12%) was treated as return of capital.
Looking at the fund's prospectus, total return was 8.76% in 2020, which was reduced to 7.88% after taxes on distributions and 5.18% after taxes on distributions and sale of fund shares. Since inception, the fund had an average annual total return of 9.03%, 6.63% after taxes on distributions and 5.9% after taxes on distributions and sale of fund shares. These returns after taxes assume the highest marginal federal tax rate and doesn't include any state/local taxes.
In my opinion, this ETF might be worth looking into for somebody that really just wants to generate monthly income and isn't overly concerned with downside risk or missing out on upside potential. For me, I'm almost looking at this as a riskier high-yield, long-term bond with a somewhat variable coupon.
Feel free to point out anything you think I missed in the comments, or if you have a different view/approach with these types of ETFs.
Sources and places to research further:
https://www.globalxetfs.com/content/files/QYLD-factsheet.pdf
https://www.globalxetfs.com/content/files/Global-X-Covered-Call-ETF-Tax-Primer.pdf
https://www.globalxetfs.com/prospectus-regulatory/?id=2951
Chart is from ETF.com total return comparison tool
#learning #duediligence #newinvestors #DRIP #dividends
*For informational purposes only, not a recommendation to buy or sell a specific security. Always read a fund's prospectus before investing and ensure you understand the risks, costs and tax considerations.
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