ETF with Covered Call ideal for stable income seekers??

The ETF products have evolved so much that almost any theme, sector, value/growth, dividend etc that you can think of are available in the US market, so much so that one is spoilt for choice.

One of the dilemma in selecting which ETF is better also depend on the objective as well as risk and return tolerance of investors. Often, there is trade off between these ETFs.  

For purpose of illustrating one of the trade off , I have used the following 4 ETFs :-

QQQ (PURPLE line in chart) - Invesco QQQ is an exchange-traded fund (ETF) that tracks the Nasdaq-100 Index. The Index includes the 100 largest non-financial companies listed on the Nasdaq based on market cap. Current dividend yield is 0.51%, distributed quarterly.

SPY (BLACK line in chart) - is the SPDR S&P 500 ETF Trust seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500 Index, which consists of the 500 largest companies on US market. Current dividend yield is 1.3%, distributed quarterly.

XYLD (RED line in chart) - The Global X S&P 500 Covered Call ETF (XYLD) follows a “covered call” or “buy-write” strategy, in which the Fund buys the stocks in the S&P 500 Index and “writes” or “sells” corresponding call options on the same index. Current dividend yield is around 12%, distributed monthly.

QYLD (GREEN line in chart) -The Global X Nasdaq 100 Covered Call ETF (QYLD) follows a “covered call” or “buy-write” strategy, in which the Fund buys the stocks in the Nasdaq 100 Index and “writes” or “sells” corresponding call options on the same index. Current dividend yield is around 14%, distributed monthly.

Please do note that foreign individual is subject to 30% withholding tax on US dividend. 

The chart above does not take into consideration of dividend paid as it is the price of each ETF. Just to give some comparison in terms of return (ex-dividend) basis from Jun 2013 to Apr 2022 (almost 9 years). Numbers below are quick estimates from website without verifying the actual dividend paid over the last 9 years:-

Cummulative price appreciation (dividend pay out not factored in):-

QQQ   +386% (annual dividend around 0.3%)

SPY    +177% (annual dividend around 1.2%)

XYLD   +22% (annual dividend from 8 - 10%) 

QYLD   -13% ( annual dividend from 9 - 12%)

The last 2 years has seen drastic growth in Tech sector, especially after the covid pandemic, hence QQQ's return has been remarkable in the last 2 years while SPY also consists of many giant tech companies also recorded impressive return. In comparison, ETFs with covered call strategy(XYLD & QYLD) while providing good and steady dividend income about 10% p.a, did not show good capital gain as they sell covered call and lost the upside potential when price keep going up and Call being trigerred. Hence, even with the high dividend* included, ETFs with covered call strategy will still fall behind on total return in the growing market, especially if the growth is fast and significant.

We can see during 2014 to 2018 when the growth was not that significant, the total return gap between straight forward ETFs and Covered Call ETFs are not that big and I would say during the down market, Covered Call ETFs would probably provide the cushion with Covered Call strategy to continue with good dividend income though the price will fall just as the normal ETFs.

Hence, if we seek stable income eg retirees who need monthly cash flow,  and willing to trade off with potentially high capital return, ETFs with covered call strategy may not be a bad option. There is always an ETF that fit into one's objective but no ETF can meet all needs (capital gain, dividend, steady, monthly, etc).   

 

 * Non US resident is subject to 30% withholding tax on dividend.

Always keep an open mind

 

After investing for the last 30 years, only the last 2 years have prompted me to keep an open mind about investment - thanks partly to Covid which has changed people's life, economy and many more aspects.

Though I have invested in Bursa, HKEX & SGX for many years but was dragging my feet to explore US market, partly because of the time zone that caused the concern if anything major happened in US stock market while I am sleeping, I could not re-act fast enough. I always felt more comfortable with companies that I think I understand more because they are closer to Malaysia :(). In addition, I always imagine with so many derivative products on US market and so many hedge fund in the market to slaughter small retailers, the risk is so much higher. After all, I heard some very successful investors in Malaysia only invest in Bursa !!

What happened the last 2 years ( especially after the departure of both my parent in 2020) has prompted me to think more openly and continue with my passion in investing - to earn and also to learn more about financial products. That is my passion.

The 1st thing that came to my mind, comparing all the stock markets' historical  performance, US stock market has the most impressive long term return for whatever reason (whether QE, or almost all the world's Top 500 companies are there etc). So I asked myself, is it easier to invest in good companies in a market that has shown long term growth or try to find a few hidden gems in a market that has not been growing?? If I have very good insights and industry knowledge in a particular slow or no growth market eg Bursa , yes, I should focus there because I believe I could find the shining star easily. Otherwise, I believe it is easier to pick good companies in a growing market and likely end up a winner in the long run. 

I have learned so much more about investing in US recently,  ETF - leveraged & inverse, options and gain reasonably good understanding of the usefulness of these products in risk management eg hedging using inverse ETF or options, there are in fact very good products if one understand and manage the risk accordingly. 

Options is something that I have been resisting in the past as many investors/fund collapsed due to this product. Though I had some basic knowledge about it from my Uni studies but that's far from adequate to give me the confidence to even learn more and explore this product. Well, I finally told myself to keep an open mind, learn and learn more about this product and why some investors lost big and how to avoid that, why this product is still available if it is all that bad, how Warren Buffet made good use of this product. It is in fact a very useful product - it provides avenue for monetisation of the equity holdings that we have and make some return for idle cash while waiting to fish at bottom. If we don't understand the purpose of option and just see it as stocks/products for trading purposes, then we could expose to unlimited loss when thing goes the other direction. 

I am glad that I keep an open mind and finally look at what option is all about,  I saw something I didn't or refused to find out in the past. Investing is not just about earning, it is learning too !! 

 

   

Will you be different this time?

There are many write-ups and articles on how stock market performed during and post war period, there was not even one time market did not recover because the market never "die", very likely the impact on stock market from this war will not be different and market will recover and continue its trajectory. I guess the more relevant question should be..how do we ensure we survive during the crisis and enjoy the gain brought by post crisis recovery. Yes, this time is no different for the market, it may still be volative and go down more, but it will recover once the crisis is contained/resolved/or can be on going for much longer with no expectation of major shock. So will you be different this time? 

Besides investing in financially sound and profitable companies, I now put into practice what I have learnt for so long but never have the gut to explore. I have decided to learn how to hedge my portfolio with inverse ETF [ CFD could be my next learning subject :)]. My main purpose is not to short the market or try to profit from the falling market, instead I would like to protect my portfolio value from falling too much and get emotionally affected, that may lead to unnecessary action (sell at depressed price) or inaction by ignoring what is happening (do nothing when crisis just started). 

Through my first 2 months (in 2022) experience of enduring volatile market with inverse ETF, it did provide the hedging expected and reduce my anxiety during the falling market as the fall in value of portfolio is mitigated during the fall, of course the gain is also partly offset by the hedging when market is up. The objective of hedging during crisis is to mitigate the fear of major losses, which may result in smaller gain should the market stage a strong rebound too fast. But it served the purpose, reduce the anxiety and stress during volatile and sharp fall market. For that, I am positive about the objectives of these financial products (inverse and leveraged ETFs) -  hedging and leveraging seems to work well to address my concern. 

I have now moved into the next learning subject, close the short position(inverse ETF) and build long position via long leveraged ETF into the portfolio in anticipation of market recovery as I believe in past statistics - bear market duration is usually shorter than bull market. yes, this will not be the last crisis and we will see many more crisis if we live long enough. 

If you are not happy with how you handled your investment in the past crisis, how would it be different to you this time or the future crisis when it happens? I believe in continuous improvement through continuous learning and in fact, I am excited this time :) .