Predictable Portfolio Income During Unpredictable Times: My Favorite High-Income ETF That Pays Me Every Single Month

When it comes to "unpredictable times," I'd argue we're in the thick of it.

Between underwhelming Q2 earnings reports from the Magnificent 7, troublesome inflation, the "Yen Carry Trade" unwinding, and most recently the -818,000 downward revision of nonfarm payrolls — times are quite unpredictable. 

As we all know, the stock market hates unpredictability. 

So far year-to-date we've experienced multiple S&P 500 sell-offs greater than -5%, the VIX spiking to 65, and a presidential candidate "hot swap." To start the year, the market was pricing in seven rate cuts by the Federal Reserve — today these odds have fallen to just two to three.

2024 has been anything but predictable. 

However, there seems to always be predictability in my own portfolio — especially when it comes to generating monthly income. In this post, I'm going to share an ETF that marks the foundation for my income-focused portfolio — the NEOS S&P 500 High Income ETF SPYI. 

Specifically, I'm going to review three important characteristics: 

1. What this ETF is, and isn’t
2. Year-to-date total performance
3. Monthly distribution history

Let's begin!

What This ETF Is, And Isn’t:

2023 marked the rise of the covered call ETF — as it seemed like every ETF issuer decided they wanted to get in the game. However, all covered call ETFs aren't built the same. As a conscious investor, you need to look for three things when choosing a covered call ETF to add to your portfolio. 

What is the ETF investing into?

This might seem simple, but contrary to popular belief, the most widely recognized covered call ETF by assets under management JPMorgan Equity Premium Income ETF JEPI doesn't actually invest into the S&P 500 — but instead their fund managers pick ~130 stocks they believe exhibit "attractive risk / reward characteristics," according to their fact sheet. 

Before you invest into a new covered call ETF, make sure they're actually holding all constituents of the index their Summary Prospectus claims they benchmark against.

How Are The Option Contracts Written? 

If you aren't familiar with how covered call option contracts work, let me explain them to you. 

Let’s use Microsoft Corporation MSFT stock as an example. 

To buy 100 shares of Microsoft today, you would spend $41,679 as the stock price is currently $416.79. If you owned 100-plus shares of MSFT and you believe the stock price will remain stagnant or even begin to come under pressure, you may be enticed to sell a “covered call” and collect a cash “premium” paid to you by the buyer.

Or perhaps you have 500 shares of the underlying security and want to lower your position to recognize some of those gains — in this instance, you would also want to sell a covered call.

For example, let’s say you wanted to sell a $430 covered call option on MSFT, as shown in the option chain above. You could earn a premium of $5.70 per share, or $570 for the entire contract. When a buyer agrees, you will receive the $570 cash premium into your account immediately.

If by the expiration date (September 27), the shares of MSFT are trading below $430 (strike price), you keep the $570 as profit and the option contract is considered worthless because the option buyer would be better off buying shares on the market, which is lower than the strike price.

But if by the expiration date shares of MSFT rise above the $430 strike price, say to $450, you would be required to sell your shares for $430 to the option buyer. They instantly buy the shares at $430 that are worth $450, so a $20 per share gain for them, the option seller would not partake in.

Now let’s talk about the risk. The risk the seller is taking on by selling these covered calls is the risk of losing out on potential upside, assuming the underlying security trades above the strike price and the buyer exercises their contract.

To mitigate this risk, you could sell covered call options on MSFT further and further “out-of-the-money,” which would lower your chances of actually having to sell the shares to the buyer at a price lower than what the open market is paying. However, the higher the strike price, the lower your premium might be.

We’re only scratching the surface with options, as there are countless strategies used to achieve numerous outcomes. With that being said, it makes a lot of sense as to why investors use this strategy to generate income with their portfolios.

As you could imagine, when covered call ETFs write their option contracts further and further "out-of-the-money" — this leaves more and more upside potential. If the strike price is +5% "out-of-the-money," the price of the ETF itself can trade higher as it gains value both by the premium collected and the underlying index rising in price. 

If you want your covered call ETF's price to rise in value over time, a good thing in my opinion, you want to make sure their fund managers are writing contracts "out-of-the-money." 

How Is The Income Taxed? 

Getting paid a monthly distribution is great, but not when it's taxed as ordinary income — like in the case of JEPI. More tax-efficient covered call ETFs use something called Section 1256 contracts to generate income for their investors. The income generated through these contracts are taxed at 60% long-term capital gains and 40% short-term capital gains. 

Additionally, the very-most tax-efficient covered call ETFs pay their investor distributions in the form of something called a "Return of Capital." This allows their investors to not pay taxes on the income during the same calendar year it's received.

Back To SPYI…

For you to understand what this ETF is… and isn't… you need to also understand how muddy the waters can be. This is a covered call ETF that according to their Summary Prospectus…

"…seeks to generate high monthly income in a tax efficient manner with the potential for equity appreciation in rising markets.

SPYI is an actively-managed exchange-traded fund that seeks to achieve its investment objective by investing in a portfolio of stocks that make up the S&P 500 Index and a call options strategy, which consists of a mix of written (sold) call options and long (bought) call options on the S&P 500 Index."

SPYI’s Summary Prospectus

SPYI's fund managers are buying all 500 constituents of the S&P 500 — which means as the index adds and subtracts companies from their roster, investors in this fund will gain / lose exposure to those names automatically. 

SPYI writes out-of-the-money option contracts, which means investors are able to both 1) collect income from the premium generated by selling the contracts and 2) experience some upside price appreciation in rising markets.

Unlike JEPI's equity-linked notes, SPYI writes covered call index options that are classified as Section 1256 contracts — allowing the income generated for their investors to be taxed much more efficiently. SPYI's fund managers roll their option contracts forward every month, allowing their investors to be paid on a consistent basis. 

The monthly distribution paid to SPYI investors (for the most part) is classified by the IRS as a return of capital — which as mentioned earlier — is not taxable during the same calendar year it's received. 

Now that you understand what SPYI is… and isn't… let's move on to its total performance year-to-date. 

Year-to-Date Total Performance

SPYI was introduced to the market in August of 2022 in the midst of our most recent bear market. 2023 was the ETFs first full-year of performance — delivering a total return of +18.4% to investors. 

Compare this +18.4% total return to JEPI's only +9.8% total return during 2023. 

We're now eight months into 2024 and SPYI has delivered a +14.0% total return to its investors (as of 9/4/24) — compared to JEPI's only +10.0% total return during the same period of time. 

As explained above, the reason SPYI has been able to deliver a higher total return than JEPI has everything to do with the two funds' compositions. Remember, SPYI is fully invested into the 500 constituents of the S&P 500 — allowing investors to realize the recent upside the index has experienced since its bear market lows in October of 2022. 

JEPI's fund managers' ~130 stocks they thought exhibited "attractive risk / reward characteristics" simply haven't delivered upon the "reward" side of the equation. 

That doesn't mean they won't some day — but while JEPI investors wait for those hopeful returns, I've been capitalizing on what is now over +12.0% of incremental total returns delivered to SPYI investors since January 1st of 2023 (as of 9/4/24). 

Monthly Distribution History

The entire theme of this post is "predictability," and that's exactly what SPYI is inside of my portfolio — predictable. 

Since inception, SPYI has religiously paid investors a 1% distribution every single month. What started at $0.49 per share in September of 2022 has only dipped as low as $0.46 per share (bear market lows in 2022) and is now up to $0.56 per share (new all-time highs in 2024). 

The income distribution paid to investors is consistent, does not substantially vary, and is always on time. 

Compare the above image (SPYI's monthly distributions) to the below image (JEPI's monthly distributions) and you'll begin to see what I'm talking about.

Just over the last 18 months, JEPI's monthly distribution went from $0.44 per share down to $0.29 per share, back up to $0.43 per share before plummeting again to $0.30 per share — and now sits the lowest it's been in three years. 

This is NOT stability nor predictability. 

Think of it this way, JEPI investors experienced a -34% haircut on their monthly income without warning. SPYI investors only experienced a -6% haircut on their monthly income.

Summary

As an income-focused investor, I want exposure to long-standing indices like the S&P 500. I want tax-efficiency, like that afforded to me through Section 1256 contracts and return of capital. I want strong total performance in rising markets, and consistent and predictable income during times of uncertainty. 

JEPI fails on all three of those demands. 

SPYI continues to champion them year after year. 

Disclaimer: This is not financial advice or recommendation for any investment. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

Austin Hankwitz is a writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking. In some circumstances, he has a business relationship with a company whose stock is mentioned in this article.

Each investor is responsible to conduct their own due diligence and to understand the risks associated with any information that is reviewed. The information contained herein does not constitute and shouldn't be construed as a solicitation of advisory services. Consult a registered financial advisor and/or certified financial planner before making any investment decisions.