A Look At The Boom In Income Focused Nasdaq ETFs (2024)

ETFs with embedded options selling strategies have proliferated over the past few years, with several new funds coming onto the market attempting to generate high income by using covered call strategies. As technology stocks tend to have higher levels of implied volatility compared to the S&P500, the strategies that buy the Nasdaq 100 and sell offsetting call options have been able to offer exceptionally high yields. In this article I will take a look at the strengths and weaknesses of the main Nasdaq enhanced income ETFs on the market, before offering a note of caution about their efficacy in current market conditions.

Comparing The 3 Main Enhanced Income ETFs

There is not much between the three main Nasdaq 100 enhanced income ETF. They all sacrifice upside in exchange for option income while maintaining downside risk, but some subtle differences could impact their performance under different market conditions.

The Global X NASDAQ 100 Covered Call ETF (QYLD) was launched at the end of 2013 but assets under management only begun to rise significantly over the past few years. Its returns have lagged significantly since inceptions, generating 7.6% annual returns, 10pp less than the Nasdaq 100. The QYLD's underperformance reflects its strategy of selling monthly options that are at the money or as close as possible, which means that it barely participated in any upside in the Nasdaq 100. Almost all its returns are generated by the options premiums.

The JPMorgan Nasdaq Equity Premium Income ETF (JEPQ) has been around since May 2022 and its assets under management have ballooned since then, allowing it to overtake the QYLD. The JEPQ has outperformed the QYLD since its inception due to its strategy of writing monthly 30-delta out-of-the-money calls, whose strike prices fluctuated around a historical average of 2.5% above the index price. This enables the ETF to participate in some upside in the event of Nasdaq rallies at the expense of slightly lower option income, which explains why its dividend yield is lower.

Finally, the Defiance Nasdaq 100 Enhanced Options Income ETF (QQQY), which came onto the market in September last year, does not sell calls but sells puts. It does not hold the Nasdaq 100 itself, but holds Treasuries, and sells daily options to realize rapid time decay by selling in the money puts with 0DTE (zero days to expiry). This enables the fund to generate higher yields than the QYLD and JEPQ, but like the QYLD the QQQY offers almost zero exposure to capital gains, which explains why it has underperformed the JEPQ in the recent Nasdaq 100 advance. The QQQY also has a higher expense ratio, charging 0.99% compared with 0.6% for the QYLD and 0.35% for the JEPQ.

Current Conditions May Not Be Suitable For Selling Volatility

The high income offered by these ETFs suggests that they will outperform the Nasdaq 100 itself over the coming years as the prospect for significant further capital gains from current valuations seems slim. However, current conditions do not seem conducive to selling volatility on tech stocks. The ideal conditions for this strategy are when implied volatility is high, offering high call option income, and markets trade sideways. During bull markets the strategy tends to underperform relative to long only as call options lose money, acting as a drag on returns. During market crashes, the steady income generated by call sales does little to offset the capital losses on underlying holdings. Currently, implied volatility levels are low, meaning that option income will be limited, while the risks of a large directional move are growing.

On the upside, there is a growing risk that the recent break to new all time highs triggers panic buying of the kind not seen since late-1999, when the Nasdaq 100 doubled in less than 6 months from already extreme valuations to historic bubble valuations. On the downside, there is a growing risk that the Nasdaq suffers a downside reversal as it recouples with bond yields, which imply fair valuations of less than half of current levels. A permanently high plateau, as implied by options markets and Wall Street analysts seem highly unlikely.

Conclusion

There has been a surge in interest in Nasdaq 100 enhanced income strategies in recent years, with QYLD, JEPQ, and QQQY representing the main ETFs. Bulls would be better off in the JEPQ as this offers greater upside potential, while those looking to maximise income would be better off in the QQQY. The current juncture seems like a bad time to own these three income based ETFs, regardless of whether you are bullish or bearish, as implied volatility seems too low relative to the risks of a sharp rise or reversal. Short sellers would be best off selling the QQQY as it offers greater exposure to daily declines due to its high are a result of shorter term option sales.

I am a full-time investor and owner of Icon Economics - a macro research company focussed on providing contrarian investment ideas across FX, Equities, and Fixed Income based on Austrian economic theory. Formerly Head of Financial Markets at Fitch Solutions, I have 15 years of experience investing and analysing Asian and Global markets.