A few weeks ago, I took a look at the QYLD
ETF, or what I like to call q-yield, which uses a covered call strategy on the Nasdaq
100 index to provide investors with a 12% annual dividend paid monthly. I got a great response from that video, which
I really appreciate, but I also got a handful of comments saying that the NUSI ETF, which
I’ll call NUSI, is even better, with a current annualized yield of about 8% paid monthly. So in this sort of a sequel to my QYLD video,
we’ll be taking a deep dive into the NUSI ETF, which is the Nationwide Risk-Managed
Income ETF. We’ll start by breaking down the fund’s
strategy, which has some interesting parallels and surprising advantages over the QYLD ETF. By the way, if you want some more context
to the QYLD comparison, be sure to check out that video for all the details. Next, we’ll compare how NUSI performs in
different market environments, and how it compares to QYLD in each one. Then, we’ll discuss the taxation of dividends
from the NUSI ETF. This is huge to consider for any income-focused
investor, and I personally learned a lot by taking a closer look at the fund’s clever
tax strategy. Finally, I’ll share some of my thoughts
on NUSI based on what I’ve learned picking apart a few of these options-based income
funds. Here we go! NUSI uses something called a protective net
credit-collar on the Nasdaq 100 index. I know that sounds like a bunch of random
words, so we’ll break it all down starting with the underlying index. To start, NUSI invests in the Nasdaq 100 index,
which are the 100 largest stocks by market cap trading on the Nasdaq, excluding financial
stocks. The Nasdaq is considered to be heavy into
tech businesses, so this is going to include stocks like Apple, Amazon, Tesla, Facebook
and so on. This also makes the Nasdaq 100 a more growth-oriented
investment, which has outperformed the S&P 500 so significantly in recent years. Investors can easily access the Nasdaq 100
with the QQQ ETF, which holds all 100 of its stocks weighted by market cap. However, NUSI purchases each individual stock
to replicate the holdings of the index exactly, which is also the approach that the QYLD ETF
uses. Of course, being a growth-oriented index,
many of the stocks in the Nasdaq 100 pay little to no dividends. The NUSI ETF uses a two-step options strategy
to generate cash flow from its Nasdaq 100 holdings, which allows investors to collect
monthly dividends while also benefiting from some of the upside potential of the underlying
stocks. And this is where we get into that protective
net-credit collar term. The NUSI Protective Net-Credit Collar Strategy
The protective net-credit collar is made up of two steps: first selling a covered call,
and then buying a protective put strategy. Let’s take a look at how this unfolds. The covered call strategy is the primary tool
for generating cash for the fund, and thereby dividends for investors. Covered calls are an options strategy that
can be employed when you own the underlying shares. In this case, because NUSI owns shares that
replicate the Nasdaq 100 index, they’re eligible to sell a covered call contract on
the Nasdaq 100 index. When selling a covered call, you give someone
else the right to buy your shares if the price increases to a certain point, known as the
strike price. The buyer pays you what is known as a premium
for this contract. If we take a look at the QQQ ETF as an example,
trading just under $329 at the time of writing, we could sell a covered call with a $330 strike
price. In doing so, we’ll get paid approximately
$11.34 per share in premium. But if the price moves up to $330 and the
buyer chooses to exercise the contract, we’ll be forced to sell our shares at that strike
price, forgoing any additional profits that we might’ve earned if we just held onto
our shares without creating the covered call contract. On the other hand, if the price doesn’t
move up, we can keep our shares and the cash we collected in premium. And this is the exact strategy that NUSI uses
on its Nasdaq 100 holdings, but it sells a covered call on the entire Nasdaq 100 index
rather than individual holdings. This has a few key differences from selling
covered calls on shares. First, these call options will be settled
in cash, not by selling the underlying shares to the buyer. So instead of liquidating or transferring
holdings, NUSI would simply pay the cash value if the option is exercised. Second, unlike stock call options, index call
options cannot be exercised early. They can only be exercised at expiration,
so in this case, the price of the Nasdaq 100 index doesn’t matter too much until that
final day where the buyer has the opportunity to exercise. But overall, the covered call strategy that
NUSI uses is a simple and effective way to generate cash from the Nasdaq 100 index. They repeat this every month to generate consistent
cash flow and fund their monthly dividends. The one risk with this strategy is that you
pretty much eliminate any chance of capital appreciation, because you are capping your
potential gains at the strike price you select for the call option. For investors who prefer dividends to capital
appreciation, this may work just fine, but it’s not the most effective strategy in
a bull market because you’ll be missing out on returns via growth. But we’ll talk more about market conditions
in a minute. The second component of the NUSI strategy
is known as a protective put option. They’ll use cash they earn from selling
the covered call to purchase one of these options, which provides downside protection. Buying a put option gives you the right to
sell your shares at a set strike price, regardless of where the shares might actually be trading
at. So if you own a stock at $100 and you’re
worried it might drop, you could buy a protective put with a $95 strike price. This way, if the price drops below that $95
mark, you’ve locked in your ability to sell your shares for $95, capping your potential
losses at $5 per share. This will limit any significant losses that
might be caused by sudden market movements. So in the case of the NUSI ETF, the fund will
purchase a put option just below market price. Again, this protects the value of the portfolio
and prevents substantial losses. This is a unique component to the fund that
we don’t see in QYLD or other covered call ETFs, and we’ll talk more about how that
impacts returns in a minute. To recap, the fund will first sell a covered
call for a cash premium. It uses some of this to purchase a protective
put, limiting downside risk. Whatever cash is leftover is paid out to investors
via a monthly dividend distribution. The fund will also distribute capital gains
via dividends on an annual basis, which will be made up of any dividends from the underlying
holdings or the sale of any holdings. Finally, if there is any premium leftover
above their targeted distribution rate, they’ll reinvest it into their underlying holdings
which should drive continued portfolio growth over time. So now that we understand how NUSI works,
I want to consider how it might perform in different market environments, and specifically
in comparison to QYLD. First of all, both of these funds benefit
from a volatile market. More volatility means that options premiums
are higher, so both funds will generate higher amounts of cash from selling covered calls. However, this benefit may be less noticeable
depending on which direction the market moves in. In a rising market, as we touched on earlier,
you have the risk of triggering the covered call option that will have to be settled at
the end of the month. This will effectively limit the growth of
the portfolio. On the bright side, the fund still gets the
cash premium from the covered call, so the dividend will be unaffected. But in these cases, investors are usually
better off holding the underlying assets, perhaps via the QQQ ETF, where they can enjoy
a higher total return. This is where QYLD falls short in my opinion. However, NUSI has a distinct advantage in
this situation. The covered call options can only be exercised
by the buyer at the end of the month, and the fund managers have the ability to close
out these positions early at their discretion. So, if it looks like the underlying holdings
of NUSI are going to increase significantly, they can close out the call option and prevent
making that cash settlement at the end of the month. With this strategy, they can uncap the growth
of their holdings, enabling investors to benefit from some of the capital appreciation that
you completely miss out on with QYLD. So I really like that this fund still has
the potential for some upside growth, but this also comes with the risk of trusting
that the fund managers will make the right decision, which is not a guarantee. Overall, we would expect NUSI to perform slightly
better than QYLD in a bull market, even though it’s still not the preferred strategy for
investors seeking highest total return. In a falling market, NUSI should outperform
other covered call strategies. It’s protective put component will limit
portfolio loss while continuing to provide dividends for investors. QYLD on the other hand, has no downside protection
and nothing to limit losses besides cushioning them with covered call premiums. So a falling market is really where NUSI shines. In a flat market, both of these funds will
generate dividends for investors while the underlying assets may not be producing returns,
which could be a great way to earn returns in an uneventful market. However, with lower volatility, these dividends
may also be lower. QYLD is likely to outperform NUSI in these
cases, because it’s not using its premium to buy protective puts. Therefore, it will have more cash to distribute
to investors. In comparison, NUSI will be producing lower
dividends because of the costs of its protective put strategy. If you compare QYLD to NUSI over the last
year, we can see these benefits in action. Obviously, NUSI fared much better during the
massive sell-off in March thanks to its protective puts. But interestingly, it doesn’t seem like
NUSI has offered substantially more growth since then. Although it may have had some periods of outperformance,
QYLD offered slightly higher returns since the recovery started in April of 2020. Unfortunately, NUSI has only been around since
2019, so we don’t have too much information to look at to see if it will really deliver
extra returns through growth over the long-run, even though it's designed to have that potential. As an options-driven income strategy, the
NUSI ETF has some important tax implications for investors. Ordinarily, the cash settled index options
used by NUSI are taxed 60% at the long-term capital gains tax rate and 40% at the short-term
capital gains tax rate. So when the cash premium is directly passed
through to investors, that would be the breakdown for tax purposes. However, if NUSI distributes capital gains
to investors, these could be taxed at short-term or long-term rates depending on how long they
held the shares from which they realized returns. So you could actually be getting a pretty
diverse mix of dividend sources and tax treatments from NUSI distributions. But it turns out this isn’t the case, as
I discovered that they’ve actually been distributing dividends made up almost entirely
of return of capital, which led to some deeper research. For the cash designated as a return of capital,
there are no immediate tax obligations at all. Instead, taxes on these dividends will be
deferred until you sell your shares. This means that as the dividends are currently
made up, investors are essentially collecting tax-free distributions which can provide a
lot of benefits. While a return of capital can definitely be
a bad thing in some cases, it looks like NUSI is actually using it to benefit investors. With this strategy, investors have more flexibility
on when they pay taxes on their distributions. This can accelerate dividend reinvestment
or simply provide more cash up-front, compared to receiving standard dividends taxed as capital
gains. We can tell that this is beneficial for investors
because the NAV of the fund is still growing, creating a total return that is greater than
the distribution rate. This means that the return of capital distributions
are not currently eating away at the NAV or putting the portfolio at risk. Therefore, investors can enjoy tax benefits
without worrying about their initial investment losing value with each distribution, which
is exactly what you want to see. I know this can be a complicated topic, so
I went in depth with everything about return of capital in a previous video. Be sure to check that out for everything you
need to know surrounding these kinds of distributions. Overall, I was expecting to like NUSI more
than QYLD due to its downside protection. After all, losing portfolio value is one of
the biggest risks with these yield-oriented investments, and we saw that the protective
put strategy certainly works to preserve capital. When you combine this with the potential for
NUSI to offer growth exposure to the Nasdaq 100 index, it seems like a strong choice. However, there’s no clear indication yet
that this is actually working. Maybe after a few more years of data we’ll
have a better idea, but for now, NUSI has yet to provide any substantial growth over
QYLD. So based on what we’ve seen so far, I feel
like NUSI only makes sense if you’re expecting some really bad times in the market and need
to maintain some level of income from your investments. Again, in a flat market, QYLD is likely to
perform better, and in a bull market, you’re better off holding the underlying assets via
the QQQ ETF for a greater total return. One of the interesting things to me is that
there are so many funds that use the covered call strategy to generate income, but the
ones built around the Nasdaq 100 seem to be the most popular. You also have options like XYLD which use
the S&P 500 or RYLD which use the Russell 2000. Ultimately, the Nasdaq 100 has the highest
volatility, which means it will generate the highest premiums and the highest dividend
yields for investors, which probably explains the popularity. But in all of these cases, if you understand
how the underlying options strategies work, you’ll have more control over your investments
if you just purchase shares of the index ETFs and perform the strategies yourself. You’ll also save on expense costs. On the downside, you’ll forgo the passive
convenience of an ETF and miss out on the potential benefits of return of capital if
that’s something you’re interested in. In any case, I’ve been fascinated to learn
how many different ways you can piece these different instruments together to customize
an investment strategy based on your goals. And at the end of the day, that’s what I
find so interesting about investing and what inspires me to continue learning more. I hope you guys enjoyed this breakdown of
the NUSI ETF, and if you have any questions or feedback I would love to hear from you
in the comments. Otherwise, I’ll see you guys next week.
