Market volatility and uncertainty are likely to persist in at least the first half of 2023 with Federal Reserve rate hikes looming and continued economic slowing. In such a continuing challenged environment, income-seeking funds have become a top priority for many advisors and Troy Cates, co-founder and managing partner at NEOS recently appeared on ETF Prime with Nate Geraci to talk about their lineup of options-based income ETFs and the opportunity for options-based investing this year.
NEOS offers a range of options-based ETFs across different asset classes: the NEOS S&P 500 High Income ETF (SPYI) within equities, the NEOS Enhanced Income Aggregate Bond ETF (BNDI) within bonds, and the NEOS Enhanced Income Cash Alternative ETF (CSHI) within 1-3 month Treasury Bills. All of the funds utilize a data-driven option strategy that is actively managed as well as SPX Index options that are classed as 1256 contracts with lower 60/40 tax rates.
“My team and I have been involved in the options-based ETF space for a number of years,” Cates explained. “We just saw the space continuing to grow, a lot of other providers had come into the space — new providers. A lot of existing providers were expanding their suite and we just wanted to bring out what we thought was the next evolution of the option-based ETFs and income in the space.”
Investing with options carries a level of complexity that can be challenging even for seasoned investors and so education about options investing has been one of the keys to unlocking growth within the space. Understanding how options roll over, when they do, how they’re taxed, and what specific functions they are performing within a strategy allows advisors to be able to confidently communicate with clients.
“I think advisors are really digging in and getting more into the weeds so they can explain to their clients why they own a specific ETF,” Cates said.
About the NEOS Income ETFs
The NEOS S&P 500 High Income ETF (SPYI) launched in August 2022 and utilizes a full-replication strategy of the S&P 500. Layered on top of that are laddered covered-call options on the S&P 500 Index. Index options offer better taxation opportunities as well as liquidity, Cates explained. It’s a systematic-rules-based ETF that uses a model to determine if and when covered calls should be sold, how much of the notional value of the portfolio should be sold, or even if a long call should be added to create a call spread. Options are reset monthly and the fund seeks a 10-12% annualized distribution yield that pays out monthly.
“How does it work in up and down markets? On the upside, our underlying data is the same but we have those covered calls — we might not participate as much on the upside but on the downside, those flat to down months in the S&P 500, we might perform a little better because we brought some of that premium in from the covered call,” Cates said.
The NEOS Enhanced Income Aggregate Bond ETF (BNDI) and the NEOS Enhanced Income Cash Alternative ETF (CSHI) also launched in August 2022 and both utilize a similar strategy that sells put options. BNDI is long the Vanguard Total Bond Market ETF (BND) and the iShares Core U.S. Aggregate Bond ETF (AGG) and then sells out-of-the-money SPX put spreads weekly to account for market volatility.
“Our goal here was to bring 200-250 basis points of income over what AGG was currently giving you in your portfolio,” Cates explained.
CSHI is long 3-month Treasuries and also sells out-of-the-money SPX Index put spreads that roll weekly but the put spreads that are even further out-of-the-money than BNDI to maintain a more conservative approach. The ETF seeks to deliver 100-150 basis points above what 3-month Treasury bills offer.
“When we built this product, Treasuries weren’t yielding anything so we were looking at ‘how do you give somebody who’s looking for cash alternative 100-150 basis points?’ Now that T-bills are yielding 4% or more, it’s a really attractive product,” Cates said.
Looking ahead for this year, Cates believes that “we’ll continue to see a lot of volatility like we’ve seen over the past year as the Fed still fights inflation but we look at it at NEOS that with that increase in volatility comes opportunity in the options market.”
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