A few months ago, I analyzed the total performance of the three most popular S&P 500 covered call ETFs in 2023: the JPMorgan Equity Premium Income ETF JEPI, the GlobalX S&P500 Covered Call ETF XYLD, and the NEOS S&P 500 High Income ETF SPYI.
The covered call ETF that came out on top was the NEOS S&P 500 High Income ETF for three reasons: they had full exposure to the holdings inside of the S&P 500, wrote out-of-the-money covered calls, and used Section 1256 contracts for enhanced tax-efficiency.
The total performance of SPYI in 2023 was 18.1%, capturing nearly 69% of the S&P 500 Index's total return last year. Compared to the JPMorgan Equity Premium Income ETF's total return of 9.8%, and the GlobalX S&P 500 Covered Call ETF's total return of 11.0%.
I share these figures because the team that built SPYI — and all of the category leading performance that came with it — has used the same techniques and strategy to build the NEOS Nasdaq-100 High Income ETF QQQI.
What Is QQQI?
The NEOS Nasdaq-100 High Income ETF is an ETF that aims to offer high monthly income in a tax-efficient manner and upside potential when the Nasdaq-100 Index (QQQ) rises.
Let’s break that down simply — as we all know, an ETF is a basket of stocks.
In this case, the basket is constructed to replicate the holdings of the Nasdaq-100 Index. Remember, the Nasdaq-100 Index sits right next to the S&P 500 Index in popularity and portfolio construction. This index tracks the total performance of the 100 largest, most-actively traded stocks listed on the Nasdaq. Think Apple AAPL, Microsoft MSFT, Nvidia NVDA, Broadcom AVGO, Meta Platforms META, Tesla TSLA… you get the picture.
The Nasdaq-100 Index delivered +54.9% returns for its investors in 2023, the best year since 1999. Again, this was largely due to the AI craze we saw by companies like Microsoft, Nvidia, and others — but incredibly impressive nonetheless.
So, what's the difference between QQQ and QQQI?
A single letter, I.
And that letter stands for income.
Think about it like this — a 55% return in an investment is awesome. However, to realize that return in your bank account, you’ll need to sell shares of stock. Considering the trailing twelve month dividend yield of the Nasdaq-100 Index is 0.52%, 99.48% of that return was in the form of share price appreciation — not cash dividends paid to you.
But what if there was an ETF that aimed to offer exposure to the Nasdaq-100 Index while also optimizing for tax-efficient income for their shareholders?
Enter QQQI.
The NEOS team has successfully done this with their S&P 500 Index equivalent ETF, SPYI — paying a 12.14% annual distribution yield (as of 3/15/24) to investors while also allowing their share price to trend higher over time. Again, SPYI delivered a total return of 18.1% in 2023 — with 12% of that being paid out as monthly income to their shareholders.
I’m a shareholder in and receive monthly income from SPYI.
Now the team is introducing QQQI — a way for income-focused investors to have exposure to the Nasdaq-100, in a tax-efficient manner.
How Does QQQI Work?
Let’s start by understanding how the normal QQQ ETF works — by investing into the same stocks that represent the Nasdaq-100 Index, the QQQ ETF experiences the same return as the Nasdaq-100 Index.
Simple enough, right? Have the same stuff, experience the same returns. I mean, this is precisely how every index-focused ETF works.
So, what does QQQI do?
They hold the exact same stocks in the exact same weightings as the Nasdaq-100 Index, as shown below. Therefore it should perform similarly to the Nasdaq-100 Index, but why not exactly the same...?
Covered call option contracts.
Let’s break what that means — NEOS says “We’re going to sell Nasdaq-100 covered calls against our holdings. We’re going to choose a date that’s about 1-month into the future, and a strike price up to 5% out-of-the-money.”
In return, they receive premium income from the buyer of those option contracts. They take that premium income and pay it out in the form of a monthly distribution to their shareholders.
Now that you understand the high-level strategy — let’s walk through the specific intricacies that set them apart from other Nasdaq-100 income-focused ETFs on the market today.
Section 1256 Contracts:
These are the type of “option contracts” they chose to use when selling their covered calls. Long-story short, the income produced when using these contracts is taxed at 60% long-term capital gains, and 40% short-term capital gains.
Compare this to the 100% short-term capital gains investors have to pay on their income when selling “normal” covered calls. Over the long-haul, we’re talking about a material savings on taxes when Uncle Sam comes knocking.
Out-of-the-Money:
By selling their option contracts “OTM,” they’re ensuring their investors can participate in upside share price appreciation.
Here’s what I mean — when you sell an at-the-money covered call, you’re guaranteeing your return upfront. If the price of the underlying equity trades higher than the total amount of premium you’ve received, too bad.
Because the NEOS team is selling covered call option contracts up to 5% OTM, investors are able to participate in some upside share price appreciation.
Sure, if the Nasdaq-100 increases by +10% in a single month — QQQI investors won’t realize that entire 10% return because they’re only writing contracts to include up to +5% in share price appreciation. But that’s the “trade-off” you make when you’re trying to optimize for tax-efficient income vs. share price appreciation.
This is very different from the GlobalX Nasdaq 100 Covered Call ETF, QYLD. Their option contract strategy sells "at-the-money" covered calls, capping the upside to the total premium generated by selling the contract. There is not upside share price appreciation participation with "ATM" covered calls.
Considering this ETF just launched late-January, we're still in the early innings of tracking its performance relative to the GlobalX Nasdaq 100 Covered Call ETF. With that being said, QQQI announced their first monthly distribution a few weeks ago at $0.5939 per share.
At time of writing (3/15/24), this comes out to be a 14.42% annual distribution yield, a whopping +2.8% higher than QYLD's 11.62% distribution yield.
Will this higher distribution yield sustain? It's anyone's guess.
However, SPYI paid investors $5.80 per share in 2023, a 12.0% yield against their $48.20 closing price on December 29, 2023 - coming in at +1.5% higher than XYLD's 12-month yield using the same time frames. And because they wrote "out-of-the-money" covered calls, the price of SPYI appreciated by +2.1% (from $46.26 to $47.24) during 2023 compared to XYLD's -1.7% (from $39.56 to $38.84).
If history repeats itself, QQQI's out-of-the-money covered call option contract strategy might outperform QYLD's at-the-money covered call option strategy from a total return perspective in 2024. However, we'll have to wait and see.
As with any covered call ETF, the downside risk is obvious - underperformance in relation to the index the ETF is tracking. However, we haven’t yet seen this take place with QQQI in 2024.
Since inception on January 30th, QQQI's total return has been 1.9% (as of 3/15/24). During the same period of time, QQQ's total return has been 1.6% (as of 3/15/24). The reason for the slight outperformance has to do with the premium collected when selling their out-of-the-money covered calls.
Simply put, QQQ has been trading sideways since mid-February — resulting in a zero total return to investors over the last month or so. Considering QQQI aims to offer exposure to the same index, it makes sense that QQQI’s stock price has also traded sideways during the same period of time. However, because QQQI seeks to distribute high monthly income for their investors and subsequently paid a $0.5939 per share distribution on February 23rd — in stagnant markets QQQI comes out on top.
QYLD's total return during the same time period has only been 1.4% (as of 3/15/24) — 50 bps lower than QQQI's — given their at-the-money covered call option contract strategy.
Time will tell just how much QQQI might underperform or outperform QQQ in 2024. Again, in 2023 SPYI only captured ~69% of the S&P 500 Index's total return. With that being said, I'm not going to begin to speculate where QQQI might land in relation to QQQ's total performance for 2024.
ConclusionThe same team that built the category leading S&P 500 covered call ETF, SPYI, has introduced a new covered call ETF, QQQI. This covered call ETF uses Section 1256 contracts to ensure tax-efficiency, writes out-of-the-money covered call option contracts, and is already beginning to show strong results early on.
As with all investments, it's important to spend time observing performance in relation to their fund's investment objective as outlined in their prospectus. When comparing very early results to "the next best thing," performance looks promising. With that being said, I look forward to revisiting QQQI's performance in 6-9 months once we've seen more distributions paid to investors.
As a fellow income-focused investor, I'm always weighing my options in efforts to determine the best possible way to invest my money. At time of writing, I'm eager to expand my small-but-growing position in QQQI. If you're interested in doing your own research on QQQI, I found this interview on YouTube to be helpful.
This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.
© 2024 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.
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