This year, I developed a great interest in funds, usually ETFs, that use covered call strategies to boost the dividend income paid to investors. I currently include three of this type of funds on my Dividend Hunter recommendations list. Beyond these, I have put together a list of more than 20 covered call ETFs, and I am reviewing each for pros, cons, and return potential. I’ll be discussing one of them below.
The Nasdaq 100 Covered Call & Growth ETF (QYLG) takes a different approach from its peers.
A covered call exchange-traded fund (ETF) or note (ETN) uses an index or index-tracking ETF or a specified commodity as the underlying portfolio. The fund then applies a covered call strategy to generate income from selling calls against the portfolio. The covered call strategy will be very rules-based, not allowing any discretion based on current market conditions.
When evaluating a covered call ETF, I review several features and factors:
- What is the underlying portfolio? What are my expectations for the future performance of that index or commodity?
- What are the details of the covered call strategy? Selling calls involves balancing current income from the option premium vs. how far out-of-the-money the strike prices are set. Selling calls puts a cap on upside stock price gains, so you need to know how much upside you could earn.
- What is the current yield? Most of these funds pay monthly distributions with very attractive yields. The income yield will be a big part of the attractiveness for individual investors.
- How does the covered call ETF’s total return compare to the underlying asset? In exchange for the rich distributions, investors need to understand selling calls puts a cap on share price gains. However, the covered call ETF should outperform in a flat to a down market.
QYLG puts a twist on the typical covered call ETF structure and strategy. The clue here is the word “growth” in the fund’s name. Also in the name is the underlying asset—the Nasdaq 100 index. This index provides the broadest exposure to large-cap tech stocks. The Invesco QQQ ETF (QQQ) can be used as the primary tracking source for the Index.
There’s another covered call ETF that uses the Nasdaq 100 as the underlying asset. That fund writes calls against 100% of the portfolio and yields about 12%. I include that fund in my Dividend Hunter recommendations list, which you can get more details on, click here.
The difference offered by QYLG is that the fund writes call options against 50% of the underlying portfolio. The result will be a lower distribution yield combined with more upside potential as the Nasdaq 100 moves higher. Since its launch on September 18, 2020, the QYLG total return comes in at 23.6%. Over the same period, QQQ returned 30.8%.
The covered call ETF picked up 80% of the underlying index return and at the same time pays monthly dividends with a 4.3% yield. For comparison, QQQ yields 0.50%. The dividend income from QYLG provides a cushion during those down periods in the market.
You can also put the QYLG dividends on automatic reinvest through your brokerage account. That move would add a little kick to your returns. I need to find a place for this fund in one of my services.