I’ve been receiving a handful of comments
asking about the QYLD ETF, so I figured it was about time I covered it and took a closer
look at the strategy. QYLD is the Nasdaq 100 Covered Call ETF, and
with a dividend yield of approximately 12% paid monthly, it attracts a ton of dividend
and income investors. Given that it’s a yield-focused investment,
I tend to read the ticker as “q-yield”, so that’s what I’ll be calling it throughout
this video. But in this video, I want to investigate the
QYLD strategy to understand how it can offer such a sizable yield every month. To do this, we’ll be diving into the QYLD
portfolio and what its covered call strategy looks like. Covered calls are a common options trading
strategy, and understanding that strategy is key to understanding this ETF. After breaking down the strategy, we’ll
take a closer look at the potential returns of QYLD, and when it makes sense to have this
fund in your portfolio. We’ll also take a look at the tax ramifications
of this ETF, which is always important to consider when dividends are involved. Last, if you like the sound of the Nasdaq
100 covered call strategy, we’ll consider a few alternatives that give investors more
control over their returns. So let’s take a look. As the name suggests, the QYLD ETF invests
in the Nasdaq 100 index, then uses a covered call strategy to generate income off of those
holdings, generating dividends for investors. We’ll break down both of these components. The Nasdaq 100 index is a market-cap weighted
index of the 100 largest stocks that trade on the Nasdaq, excluding REITs or financial
stocks. The Nasdaq 100 claims to be an innovation-focused
growth index, which as I discussed in my video comparing it to the Ark ETFs, isn’t completely
accurate. Based on the Nasdaq’s history as a technology-driven
exchange, it has naturally attracted more tech companies than something like the New
York Stock Exchange. This is why the Nasdaq 100 has outperformed
the S&P500 in recent years, because it is heavier into these tech-focused companies
that could be loosely considered innovators. I think they’re trying to use innovation
as a buzzword to compete with Ark Invest funds, but that’s just my two cents on the subject. Anyway, there are a few ways to invest into
the Nasdaq 100 index. Most common is QQQ, an Invesco ETF that tracks
the Nasdaq 100 by investing into all 100 of its stocks as they are represented in the
index. Similarly, QYLD purchases each individual
stock as represented in the Nasdaq 100 index. So this means it will be nearly identical
to the QQQ portfolio and the Nasdaq 100 index. So as we would expect, the QYLD portfolio
matches the Nasdaq 100 index almost perfectly. And this means that as an investor into QYLD,
you get “long” exposure to the Nasdaq 100 index, just like you would by investing
into QQQ or a similar ETF. However, as the Nasdaq 100 is largely made
up of growth companies that pay little or no dividends, this may not be ideal for an
income or dividend-focused investor. And that’s where the covered call strategy
comes in. Covered calls are an options trading strategy
that can be used to generate additional income from stocks, whether or not they pay a dividend. To use covered calls, you have to own the
underlying stocks. So this is something the QYLD ETF is able
to do on its portfolio because it owns all of the stocks in the Nasdaq 100 index. As an individual, you have to own 100 shares
of a stock or ETF to perform the covered call strategy. Then, you can sell or “write” a covered
call, which means you create a contract that gives someone else the right to buy your 100
shares at a certain price. Someone pays you for this contract, which
helps you earn extra cash on the stock. The catch is, if the price of the stock moves
up, the other person can execute that contract and force you to sell your shares to them
at the agreed upon price. I’ll give you a quick example with Apple
stock. So let’s say I owned 100 shares of Apple,
and I want to make more income from these shares than its measly dividend. Since I own 100 shares, I can sell a covered
call. You can see on this option chain that Apple
is trading around $134. I can sell a covered call with a strike price
of $140 and earn $4.38 per share, otherwise known as the premium. Since each covered call contract is for 100
shares, this would be an instant $438 for creating the contract. Once sold, the buyer has until the expiration
date, in this case June 18th, to execute our contract, and can only do so if the price
of Apple stock is at least $140. If they choose to execute the contract, I
would be forced to sell my 100 shares to them for exactly $140. However, if the stock doesn’t reach that
price by the expiration date, I get to keep my shares and all of the money I collected
in premium. So as you can see, if you don’t expect the
stock price to increase beyond a certain price, a covered call lets you earn some nice income
on your shares. However, it also limits your potential returns,
because if a stock shoots up, you’re forced to sell your shares at the set strike price,
no matter what price the stock ends up reaching. But in a nutshell, this is the strategy that
QYLD uses on its holdings to generate high dividends for investors. The only difference is, instead of selling
covered calls on individual stocks in its portfolio, it sells a covered call on the
entire Nasdaq 100 index, essentially tying up its entire portfolio in a single options
strategy. Let’s take a closer look here. The QYLD ETF writes their covered call contracts
on a monthly basis, with each contract expiring the following month. When they do this, they select the closest
available strike price above the current price of the Nasdaq 100 Index. This is known as an at-the-money option, because
the price needs to move very little for the buyer to execute the contract. This is different from the Apple example I
showed you earlier, because the $140 strike price was farther away from the current stock
price of $134. So in the case of the QYLD portfolio, they’re
almost guaranteeing that they won’t earn a large positive return on their portfolio,
because the contracts will likely be executed if the index above that strike price. However, the interesting thing about these
covered calls on the Nasdaq 100 index is that they can’t be executed early, unlike regular
call options which can be executed at any point before the expiration date. So the contract only gets executed if it expires
with the Nasdaq 100 index at or above the strike price. And this means QYLD covered call strategy
has some very specific implications for investors. First of all, you’re not expecting the ETF
to produce returns via price growth. The price of the ETF will fluctuate a little
bit based on the performance of the individual stocks in the Nasdaq 100 index, but only to
a certain point. You’re expecting to receive most or all
of your returns from the premiums collected from the covered call contracts. And this is why the price of the ETF has been
more or less the same since inception, bouncing between $20 and $25. It caps its own growth potential in favor
of collecting cash premiums and distributing them to investors every month. In comparison, you can see that the Nasdaq
100 index as measured by the QQQ ETF has produced huge price appreciation over the last several
years, while only offering about a half percent dividend yield. This particular chart makes QYLD look pretty
bad - but when you consider the total returns, which includes dividends, it’s historically
produced around 9% returns a year before taxes. Another important thing to understand about
the QYLD ETF is the impact of market volatility. First, because the covered call contracts
cannot be executed until the end of the month, market volatility doesn’t really matter
until the last day of the month. The NAV may fluctuate throughout the month,
but the main concern for investors should be whether the price of the Nasdaq 100 index
falls above or below the strike price of the contract written at the beginning of the month. Volatility does play a role in the value of
options contracts, because premiums will be higher in a volatile market. And that’s something we’ll consider more
in a minute, because QYLD will produce higher dividends in higher volatility, which is exactly
we’ve seen recently. But volatility aside, there are 3 potential
outcomes for QYLD in a given month, which will tell us which kind of markets we might
want to hold this ETF in. First is that the market goes down, and the
month ends with the Nasdaq 100 index priced below the strike price of the contract. In this case, QYLD gets to keep their options
premium and their stocks. While the NAV of the fund would drop in this
case, these losses would be offset by the dividends that investors receive. So in a bear market, QYLD can be a hedge against
downward price action to limit your losses and continue receiving dividends. Second is that the market stays flat, with
the index priced at or near the strike price of the contract at the end of the month. In this case, QYLD gets their options premium
and the contract would likely not be executed, so the holdings of the fund will remain the
same. This is the optimal outcome for investors,
because the NAV remains the same but you still get to collect the dividends. The last outcome is if the market goes up. In this case, QYLD still gets that option
premium, but they’ll likely have to liquidate their holdings to satisfy the contract when
it gets executed. This will have a small increase in fund NAV,
but as we mentioned, it will be limited because the holdings have to be sold at the strike
price. So if the Nasdaq index moves far above the
strike price, investors are missing out on any additional returns. Considering these three outcomes, we can speculate
as to when the best times to hold the QYLD ETF would be. As we said, it can be a good hedge in bear
markets when downward price movements can be expected. In these cases, you can still earn some returns
through dividends that can cancel out or mitigate a loss in portfolio value. We can see that QYLD has performed better
than the Nasdaq 100 in these environments. The best time to hold this kind of investment
seems to be a flat market or a highly volatile market. In a flat market, the Nasdaq 100 index would
not be producing returns, making QYLD a great way to earn returns through dividends when
the underlying assets aren’t moving. Similarly, since options premiums increase
with market volatility, this strategy would be more profitable in a volatile market. But, if the volatility skews towards the upside,
you may want to reconsider. This is because in a bull market, you’re
limiting your potential returns with the covered call strategy. You’ll still receive dividends, but your
total returns would be far greater if you just held the QQQ ETF or a similar investment. One last key thing to consider about QYLD
is the tax implications as a dividend-focused investment, because the cost of taxes can
quickly eat into the returns of this ETF. Ordinarily, gains from covered call options
in this strategy would be taxed at 60% long-term capital gains tax rate and 40% short-term
capital gains tax rate. Depending on your particular tax bracket,
you may choose to hold this in a tax-advantaged retirement account to reduce the impact of
those taxes on your returns. However, QYLD has been doing something pretty
interesting with their recent distributions. Throughout 2020 and so far into 2021, their
distributions have been 100% return of capital. A return of capital means they’re returning
a portion of your initial investment back to you, which is not immediately taxable. When you receive a return of capital, you
don’t pay any taxes on it, but it reduces your cost basis in your investment. So eventually, if you sell your QYLD shares
after receiving one of these distributions, you’ll pay capital gains taxes on an amount
equal to the difference in the current share price, and your initial purchase price minus
any dividends you’ve received. This is considered tax-deferred, because you
don’t have to pay any taxes until you sell your shares. You just have to be careful here, because
the tax hit can be pretty heavy if you’ve held for a long time and you’re not expecting
it. But this is a clever strategy that QYLD uses
to give investors more control on when they realize their tax obligation. They’re able to use any capital losses they
receive throughout the year to offset the gains from options premiums. Then, they choose to give you “return of
capital” instead of the money they’ve earned through premiums. So currently, you could be holding QYLD in
a standard investment account with no immediate tax obligation, which is great for the short
term. You just have to be aware that you will eventually
owe taxes on these dividends when you decide to sell your shares. And that’s just about everything you need
to consider about the QYLD ETF. However, I wanted to quickly point out two
alternative strategies you may also want to look into. First is performing the covered call strategy
on your own with the QQQ ETF. To do this, you’ll need to own 100 shares
of QQQ, which is about a $34,000 investment. But if you can pull this off, you’ll have
much greater control by selecting the covered call contracts you create. Then you can choose strike prices that give
you more room for upside growth or you can choose different time frames to customize
the strategy. Additionally, you’ll only be paying the
.2% expense ratio of QQQ, instead of the .6% expense ratio of QYLD. The second alternative is the new QYLG ETF. This is the perfect blend of QQQ and QYLD. In contrast to QYLD, which writes covered
calls on 100% of the portfolio, QYLG only writes covered calls on 50% of the portfolio,
and still has all of the same stocks as the Nasdaq 100 index or QQQ. So with this strategy, you’re getting more
upside potential than QYLD, but also getting a larger dividend than with QQQ. Since the high yield and covered call strategy
of QYLD is a superior choice to QQQ in flat or bear markets, QYLG, which gives its portfolio
more potential upside, might fit well into a portfolio during a volatile market or a
flat market that has some potential for gradual upside price action. Long-term, we’d probably expect to see the
yield from QYLG fall somewhere between QQQ and QYLD, likely in the range of 5 to 6%. But that’s all I’ve got for you guys on
QYLD and its covered call strategy. Leave me a comment and let me know how you’re
using this fund in your portfolio, if at all. As always I appreciate your support and I’ll
see you in the next video.
This video came across my YouTube recommendation page. I do not have any association with him but I found it helpful to better understand the investment.
This was very helpful for me, thnx for the share
This was a good video. I had some questions about QYLD and this answered them all.
He is wrong in this video. QYLD does not trade CC on the index itself. It owns the stocks from the index. Huge difference between that. It’s American style contracts. Not European style. Contracts can be assigned early and not cash settled. They trade on stocks from 100 index only. Not the index itself.
Thank you very much!