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Usually, I’m a big advocate for simplicity. In the case of options, however, simple is not always better, and we’ll look at why by studying the Global X Nasdaq 100® Covered Call & Growth ETF (NASDAQ:QYLG). This fund, launched on September 18, 2020, hasn’t had the same popularity and success as some of its newer peers for good reasons. While QYLG performs as expected, many competitors distribute more income while retaining the same total returns from their more sophisticated strategies. Due to stronger competition and competitor funds that are much more attractive, we rate QYLG a Sell.
The Premise For QYLG
It is commonly known among options traders that one of the most significant drawbacks of systematically selling covered calls for income at fixed moneynesses is the possibility of missing out on significant capital gains or worse, experiencing principal erosion. This can be seen in QYLG’s more popular sister fund, the Global X NASDAQ 100 Covered Call ETF (QYLD). For those unfamiliar with QYLD, a brief explanation of the fund is that the fund holds the constituents of the NASDAQ 100 and sells monthly at-the-money call options backed by at least 80% of the portfolio on the same index.
If we examine QYLD’s price return since its inception in 2013, we see that it lost 29.79% despite QQQ gaining 442.2% at the same time.
Essentially, if you use all your monthly distributions, your initial investment principal will slowly erode over the long term. And even if you do look at distributions and compare QYLD with QQQ on a total return basis, you’ll also see just how much systematically selling at-the-money covered calls has capped QYLD’s upside.
QYLD’s capped upside and capital erosion issues were the premises for QYLG’s launch. QYLG also systematically sells monthly at-the-money call options on the NASDAQ 100, but only on 50% of its portfolio, as described by Global X’s ETF Objective statement:
The Global X Nasdaq 100® Covered Call & Growth ETF (QYLG) seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the Cboe Nasdaq-100 Half BuyWrite V2 Index.
The idea is to target investors who want more of a middle ground between capital appreciation and income. If you’re not making full use of the distributions from QYLD, it could make more sense to opt for a lower distribution and leave a more significant portion of your portfolio for growth. Think of buying QYLG as putting 50% of your money in QYLD and the other 50% in QQQ, but with a lower expense ratio of 0.35% and without the broker fees from investing in both funds.
Since its inception in 2020, QYLG has done its job. Unlike its sister fund, QYLD, QYLG has maintained a positive capital return without accounting for distributions driven by the NASDAQ 100’s growth in the last couple of years. Additionally, with a current yield of 5.86% compared to QYLD’s 11.73%, we can confidently say that it only sells calls on half its portfolio as intended.
Higher-Yielding Alternatives That Have The Same Total Returns Exist
While QYLG has been performing as expected, I would not recommend it to any long-term buy-and-hold investor because far better alternatives exist. The inherent problem with QYLG’s systematic at-the-money call options is that it fails to adapt to market conditions. During bear markets, it will underperform its sister fund, QYLD, as QYLG receives fewer option premiums to offset the paper losses. And when the NASDAQ 100 rebounds, QYLG does not capture the upside as well as the underlying and offers subpar yields at less than 6%. So, even if QYLG is performing as expected, you need to consider the opportunity cost of investing in QYLG. Multiple funds launched recently have been able to match or outperform QYLG in total returns while offering significantly higher distributions due to more efficient portfolio management strategies. Three of them that I’ll briefly discuss in this article are the:
- JPMorgan Nasdaq Equity Premium Income ETF (JEPQ) | Current Distribution Yield: 9.50%.
- NEOS NASDAQ-100(R) High Income ETF (QQQI) | Current Distribution Yield: 15.16%*.
- Goldman Sachs Nasdaq-100 Core Premium Income ETF (GPIQ) | Current Distribution Yield: 7.83%.
*Note: Source from neosfund.com instead of Seeking Alpha for the other yields due to QQQI’s limited distribution history.
As you can see from the charts above, all three alternatives I mentioned have matched or outperformed QYLG in total return since their inception while maintaining a higher distribution rate that’s on par with QYLD. Each alternative investment has unique strategies that make it more capable of adapting to different market conditions and distributing more while retaining similar total returns. JEPQ, for example, has a data-driven asset selection process where its underlying assets are slightly different from the NASDAQ 100 and generally writes out-of-the-money call options via ELNs, which have a higher win ratio than at-the-money calls. GPIQ and QQQI are even better because their options strategy adapts to the market conditions. Both adjust the portion of the portfolio they write calls on based on market conditions, and QQQI goes one step further by changing the moneyness and potentially introducing credit spreads to protect the fund from sudden spikes in the index.
I struggle to see a good reason to buy QYLG due to the success of these alternative NASDAQ 100 covered call funds. Why buy the 5.86% yielding QYLG when other funds have 7%, 9%, or even 15% yields and perform at the same level or better in total returns? Yes, we do not deny that QYLG has performed better than funds like JEPQ, QQQI, and GPIQ regarding price returns. Your overall principal will be higher with QYLG. That said, one could always reinvest the income they don’t need with the other funds.
It just doesn’t make sense to be in a position systematically writing monthly at-the-money covered calls on 50% of your portfolio over the long term. Market conditions will change, and different options strategies will become more suitable based on what’s happening. Passive buy-and-hold investors interested in buying covered call funds should look for funds that have adaptable strategies for long-term success, and that flexibility is something QYLG does not have.
Conclusion
Although QYLG has performed as expected, competitor funds have done a far better job of distributing larger payments while maintaining the same total return. I just don’t see a good reason for owning QYLG, hence my Sell rating. Taking on options risk to get a 6% yield just isn’t that appealing when other NASDAQ 100 covered call funds are yielding more and maintaining the same total returns.