With the Federal Reserve boosting interest rates earlier this month and the potential for more aggressive hikes over the course of 2022 looming, income investors face a trying climate.
The reasoning is simple. Many bond funds, in order to deliver adequate income, have longer durations. Conversely, lower-duration fixed income assets have less rate risk, but lower income propositions. It’s a catch-22 for income-hungry investors.
One way of coping with this scenario is with covered calls. Better still is evaluating an exchange traded fund such as the Global X Nasdaq 100 Covered Call ETF (QYLD).
“Covered calls perform best when markets are rangebound. The way it works is that a fund writes (sells) call options on a specific index, either the S&P 500, Nasdaq 100, or Russell 2000,” according to Global X research. “The income from selling the options is paid out to investors in the form of yield. Investors have full exposure to the downside, as the calls expire worthless in a down market. And they have capped exposure on the upside, as the underlying can be called away. When volatility rises, the premium received rises to compensate for the higher volatility in the market.”
The $6.97 billion QYLD tracks the Cboe Nasdaq-100 BuyWrite V2 Index, meaning that it writes covered calls on the widely followed Nasdaq-100 Index (NDX). Owing to its status as home to a slew of growth and technology companies, NDX isn’t known for dividends and big yields. However, QYLD flips that script, as highlighted by a trailing 12-month yield of 13.82%, according to Global X data.
There is an element of timing that investors should consider with QYLD. Specifically, covered calls are usually best employed in lethargic, sideways markets.
“In a reasonably tight range, covered calls benefit from receiving the premium income and a potentially small improvement in the underlying equities, while not having the underlying called,” adds Global X. “In a rising market, covered calls typically underperform the overall market due to the underlying being called away, which affects the capital gain return, not the income return. In a declining market, covered calls provide a small buffer of protection due to their premium income.”
An added benefit of QYLD is steady income, as the fund has delivered monthly distributions for more than eight straight years. QYLD is one of several options-based ETFs addressing well-known domestic equity benchmarks offered by Global X.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.