The words "Nasdaq" and "high yield" don't often appear in the same sentence, but they are both great ways to describe the Global X Nasdaq 100 Covered Call ETF (QYLD +0.59%).
Not only does this ETF invest in a weighted index of some of the best-known tech stocks in the world, but it also pays an extremely high dividend yield of nearly 12% as of this writing. With that in mind, here are some of the details of how this Nasdaq covered-call ETF works and some of the things you should keep in mind before investing.
What is a covered call ETF?
A covered call ETF is an exchange-traded fund that buys stocks or other assets and sells covered calls on its positions to generate income.
If you aren't familiar with options trading, a covered call is a strategy in which an investor buys shares of a stock (or ETF) and then sells a call option, giving another investors the right, but not the obligation, to buy their shares at a certain price before a specific deadline. If the call option is exercised, the shares are sold, and if the stock doesn't reach the contract price, known as the "strike price," the option expires worthless. Either way, the covered-call seller gets to keep the initial money from selling the call option.
I don't want to get too deep into the mechanics of covered-call strategies, but the general idea is that it's a way to generate income from a stock position and still maintain some potential upside.
Covered calls can make a lot of sense with the Nasdaq
In this case, the Global X Nasdaq 100 Covered Call ETF buys the stocks in the Nasdaq 100 index in the same weightings, and then sells covered calls on the index itself.
Because the Nasdaq 100 is a tech-heavy index and its stocks can be more volatile than the average S&P 500 component, option premiums tend to be rather attractive. That's how this ETF pays an annualized distribution yield of 11.7% based on its most recent payout, compared with a pure Nasdaq ETF like the Invesco QQQ ETF (QQQ +1.25%), which has a yield of just 0.6%.
After all, while some major Nasdaq components, such as Microsoft (MSFT +1.29%) and Apple (AAPL +2.11%), pay dividends, many of its larger components don't, choosing to reinvest as much as possible in growth instead.
Benefits and drawbacks to keep in mind
The obvious benefit of using a covered-call ETF like this one to invest is income. Covered-call ETFs sell short-term options on their positions. I'm writing this on March 18 and the fund's covered calls expire on April 19, just for context. And every time it sells covered calls, it generates income that it can then distribute to investors.
It's also worth noting that with a covered-call ETF, dividend income will fluctuate over time, depending on things like options volatility premiums. But if you add up all of the fund's distributions over the past 12 months, the fund has a trailing 12.2% yield, so this can clearly be a solid income strategy.
On the other hand, the biggest drawback is that selling covered calls inherently limits upside. As a basic example, if you buy a stock at $100 per share, sell a covered call giving someone the right to buy it at $110, and the stock spikes to $150, you are obligated to sell it for $110.
The same concept applies here, and it's important to note that there isn't a ton of difference between the current value of the Nasdaq 100 and the strike price of the fund's options. As mentioned, the ETF's covered calls were about a month from expiration as of the writing, and there's just over 0.5% of upside in the index before the strike price is reached.
The short explanation is that when the Nasdaq 100 does particularly well, your upside can be limited. In fact, over the past year the Nasdaq 100 has delivered a 45% total return, while this ETF delivered a still respectable 18.5%.
Conversely, a covered-call strategy helps mitigate your downside risk in bad times. For example, the Nasdaq fell by 33% in 2022, but this covered call ETF produced a negative total return of just 19% thanks to the income it generated.
Is it right for you?
Covered call ETFs aren't right for everyone. But they can provide elevated income while still maintaining some upside potential if their underlying investments do well. If you want some exposure to the megacap "Magnificent Seven" stocks but also want to generate income from your investments, the Global X Nasdaq 100 Covered Call ETF could be worth a closer look.
