QYLD: Likely To Thrive Off Volatility Throughout The Remainder Of 2024 (2024)

Overview

Covered call ETFs make it possible to collect very large yields from relatively small investments. This makes them popular asset classes amongst investors that value income. The Global X NASDAQ 100 Covered Call ETF (NASDAQ:QYLD) offers a very large dividend yield above 11% while also providing exposure to the best companies in the world. However, the inclusion of an option strategy leaves some vulnerabilities that investors should be aware of. As a result of these vulnerabilities, the price has consistently traded downward over time since its inception in 2013.

QYLD is actively managed by Global X Management Company and has net assets totaling $8.15B. The expense ratio of the fund is pretty reasonable at 0.61%. QYLD seeks to provide a total return that aligns with the price and yield performance of the Cboe Nasdaq 100 BuyWrite V2 Index. QYLD writes call options on the Nasdaq 100 index and gives investors the chance to let the professionals handle this strategy, rather than taking on the expenses of implementing similar options strategies on your own.

Despite the price being falling over 30% since inception, the high distributions make up for this. When including the distributions, we can see that the total return since inception is 114%. Therefore, I think a fund like this would be best utilized by the investor that is at or nearing the retirement part of their investing journey. This is because these investors likely have a much higher priority on income generation that can be used to fund lifestyle expenses. Before getting into the best form of utilization of QYLD, let's first take a look into what the fund holds and what the option strategy entails.

Strategy & Vulnerabilities

QYLD's strategy is to generate income through covered call writing. Through periods of high volatility, the income generated actually grows. This is typically because higher volatility can produce higher premiums that investors can earn from selling the call option. However, this covered call strategy has some limitations, with the most notable being that upside movement is capped if the underlying assets appreciate above the strike price.

This is because QYLD implements an 'at-the money' call strategy opposed to an 'out-the-money' strategy. At the money strategies do not leave any buffer for price upside to be captured. A good example of this would be the differing strategies between QYLD and REX FANG & Innovation Equity Premium Income ETF (FEPI), which uses out-the-money call options. The visual below is a great representation of how the differing strategies affect payouts.

FEPI has a very short history, with less than a year of price movement. However, the difference in strategy goes a drastic difference in price performance despite the two funds implementing covered call strategies. We can see that FEPI's price has more frequently provided larger returns, which contributes to FEPI's outperformance in total return. This is the main drawback to the at-the-money option strategy. You are essentially forfeiting the upside potential while also remaining vulnerable to all of the downside risk of the index that QYLD tracks.

Despite the shortcomings in the strategy, QYLD is diverse in nature but has a primary weighting towards the technology sector. The tech sector is typically more volatile than others due to the growthier companies within. As a result, QYLD is able to easily generate income from the option strategy. We can see that tech accounts for approximately 50% of the fund's weighting. This is followed by communication services making up about 15% as well as consumer discretionary accounting for about 13.5%. There are a total number of 102 individual holdings within QYLD.

Since the top sector is comprised of tech companies, we can expect the top holdings to be in some of the most recognizable companies in the world right now. The top five holdings within include companies like Microsoft (MSFT), Apple (AAPL), Nvidia (NVDA), Amazon (AMZN), and Meta Platforms (META). While this is great for capturing volatility to generate income, I can't help but feel like focusing on the holdings within is a bit pointless since no upside movement is being captured anyways. However, this diverse set of holdings does help soften the exposure to any sector-specific risk, specifically to tech.

Dividends

As of the most recent declared monthly dividend of $0.1628 per share, the current dividend yield sits around 12%. This focus on monthly distributions makes QYLD a highly attractive fund for investors prioritizing income. Having a monthly distribution can help fund lifestyle expenses or can be snowballed into other areas of your portfolio that may be of better value. However, the distribution is directly linked to the fund's performance so the amount received may vary on a month-to-month basis.

We can see that the dividend payouts have remained around the same range throughout the fund's history. After the pandemic crashed in 2020, the volatility of markets increased and the payouts rose slightly. However, you are not likely to see any growth here with the dividend over a long period of time. So if you are an investor looking for a more traditional form of dividend growth over time, QYLD is not for you.

However, this doesn't mean that there's no way to increase your dividend income. In order to see any meaningful growth in dividend income here, you'd have to essentially create your own with continued contributions and full or partial reinvestment of your distribution. Using Portfolio Visualizer, we can display exactly how this would've gone down over the last decade. This visual assumes an original investment of $10,000 back in 2015. It also assumes that $500 was added to your position on a monthly basis and dividends were reinvested throughout the entire holding period.

In 2015, your dividend income would have totaled only $1,237. Fast forwarding to 2023, your dividend income would have grown to over $10,500 annually while your position value would now be at about $108,000. This scenario would be ideal for someone who is preparing to retire in the near future. By starting a position now, you have some time to build up a large income stream over time. However, I want to also point out something that I noticed on QYLD's 19a notice. The Over 96% of the distributions issued this year have been comprised of return of capital.

When it comes to closed end funds, return of capital can be damaging because it means that the fund isn't earning enough income to afford the distribution. However, with covered call ETFs such as QYLD, this return of capital is merely a tax classification as a result of the income generated from the option strategy and is not damaging in this case.

Best Use Case & Outlook

So what kind of investor is QYLD best for? In my opinion, QYLD is best complimented by a portfolio of other asset classes that can offset the price deterioration experienced. While the yield from a covered call ETF such as this generally remains higher than other asset classes like high yield bonds, MLPs, REITs, or traditional equities, it would not be wise to have a fund like QYLD make up the largest percentage of your portfolio.

A unique use case for a fund like QYLD is that dividend focused investors may be able to juice up the yield from their portfolio while simultaneously filling any holes in diversification. When I started my dividend investing journey long ago, I made the mistake of focusing too much on companies such as dividend aristocrats and dividend kings. These companies are usually within the utilities, consumer, industrial, and energy sectors. While this is a fine place to start, these companies typically do not include any exposure to tech. Tech isn't exactly known for their strong dividend yields or dividend growth, so I naturally had built a portfolio that had high levels of income but lacked proper diversification across all industries.

As stated previously, covered call ETFs like QYLD benefit from higher levels of volatility. With this in mind, I believe there are a few different factors that will continue to provide favorable volatility levels for QYLD to benefit from. To start, there are still ongoing talks about interest rate cuts. With every Fed meeting, the market shows us that it's still highly reactive. Interest rates started to rapidly rise at the mid-point of 2022, and we can actually see that QYLD has struggled to gain any upside momentum since then.

With unemployment still below 4%, inflation remaining elevated, and interest rates higher, I believe that any talks of future interest rate cuts will cause additional volatility. The Fed seems to be dragging their feet and awaiting more economic data to roll in as the months pass. Therefore, there's a chance that interest rate cuts may not actually happen until next year. Additionally, we have the US Presidential elections on the horizon, which historically has always created higher volatility in the markets. This volatility can be attributed to the uncertainty factor that elections present. Therefore, I believe that the higher level of income from QYLD will be able to be sustained throughout the remainder of 2024.

Takeaway

QYLD's covered call strategy is a great way to add some additional income to your portfolio through its option strategy. However, the usage of the at-the-money calls leaves vulnerabilities as you are capping the potential price upside while also experiencing the full effect of the downside risk. I believe that out-the-money covered call ETFs such as FEPI serves as a better alternative option ETFs. Despite the vulnerabilities, QYLD does have its use cases and ultimately provides exactly what it sets out to do, which is generate high levels of income. The monthly distributions can still provide a high level of total returns that offset the price deterioration.

The dividend yield remains around 12% and I believe that it can be sustained throughout the rest of the year. Covered call ETFs thrive in a high volatility environment and that is exactly what we are likely to experience throughout the remainder of the year in my opinion. With talks of interest rate cuts still remaining and the upcoming presidential election in the horizon, I believe this will present a lot of uncertainty in the markets which will drive volatility.

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