It’s been a bumpy ride for markets so far this year with concerns around the Federal Reserve’s monetary policy driving much of the market sentiment, a trend carried over from much of 2022. Recession concerns loom large in the minds of most investors and could bring continued challenges for equities that have underperformed in the last 12 months, and for advisors seeking income within those equities.
Finding income in such a challenged market environment has led to many advisors searching beyond their core allocations, but a relative newcomer ETF allows advisors to remain invested in their core equity allocations and is providing 50 basis points of outperformance above the S&P 500 since its inception at the end of August last year.
The NEOS S&P 500 High Income ETF (SPYI) is an actively managed fund launched last year and seeks to provide high-income opportunities for portfolios while also working to preserve the income generated through its options overlay in times of market stress. SPY allows advisors to remain invested in their core equity allocations while also seeking to deliver high monthly income: the fund has a distribution yield of 12.05% as of 12/30/22.
SPYI seeks to fully replicate the S&P 500 Index and also utilizes a call options strategy layered on top. Call options give buyers the right to buy the underlying asset at a specific price (the strike price) within the timeframe of the contract, but they are not obligated to do so.
The fund writes call options that it earns premiums on and then can use the money earned from the written calls to buy long, out-of-the-money call options on the S&P 500 Index. An out-of-the-money call option has no intrinsic value because the current price of the underlying asset is below the strike price of the call. Should the equity markets rise or fall, NEOS can actively manage the call options to capture gains in the underlying assets or minimize losses.
The options that the fund uses are not ETF options but instead are index options that are taxed favorably as Section 1256 Contracts under IRS rules. This means that the options held at the end of the year are treated as if they had been sold on the last market day of the year at fair market value and most importantly, any capital gains or losses are taxed as 60% long-term and 40% short-term no matter how long the options were held. This can offer noteworthy tax advantages, and the fund’s managers also may engage in tax loss harvesting opportunities throughout the year on the call options or the equity holdings, or both.
SPYI has an expense ratio of 0.68%.
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