There's no such thing as a perfect investment -- each one is ultimately a trade-off. Higher-growth stocks are usually riskier, for instance, while income-producing holdings often don't produce a great deal of capital appreciation.
For investors who want (or need) monthly investment income to help cover their living expenses, however, the JPMorgan Equity Premium Income ETF (JEPI 0.28%) is an intriguing prospect. Not only does its trailing yield stand at an impressive 8.6%, but it holds stocks that at least offer some potential upside.
The question is, is it the right choice for you?
Comparing and contrasting
For the record, you can find higher yields from monthly dividend ETFs. The Global X SuperDividend ETF's current yield is an incredible 9.9%, for instance, while the Invesco KBW High Dividend Yield Financial ETF boasts a dividend yield of 12.5%.
But there is a trade-off. Global X's fund owns a whole lot of smaller foreign stocks that can perform unpredictably, and often badly. This ETF has dramatically underperformed the S&P 500 since the fund's inception back in 2011, and its dividend payments made in the meantime haven't made up the difference at any point during that stretch.
The Invesco fund has fared better, but is still not a straight-up investment in the broad market. Its heavy exposure to real estate investment trusts (REITs) and similar asset management investments has limited its upside, largely due to the economic environment.
So how is the JPMorgan Equity Premium Income ETF different, and better? First and foremost, it holds the same stocks as the aforementioned S&P 500 (although the size of these holdings tends to be a bit better balanced than the top-heavy S&P 500).
There's a significant twist to this idea, though. This ETF's managers are constantly selling call options against the fund's stock holdings, generating recurring income as a result. This income is then used to pay ETF's monthly dividend.
Great, you say, but what's a call option? Keep reading.
How the JPMorgan Equity Premium Income ETF works
In simplest terms, a call option is a bullish bet that a stock (or index) will rise to or above a particular price before or by a specific date. Qualified traders and institutions can pay to make such a wager, but they must pay a counterparty to make what's essentially the opposite bet -- a bet that the stock or index in question won't reach that price level by the specified date. Indeed, this betting is so well organized that these options trade on exchanges and are dynamically priced all throughout the day just like stocks.
That's what JPMorgan is doing with JEPI. It's collecting money for being willing to take, or "sell," the other side of bullish bets someone else is making by buying call options, using its own underlying stock holdings as collateral. It's called a "covered call" strategy, in fact. JPMorgan is "covered" if it needs to sell or deliver a stock per the call option's requirements.
Image source: Getty Images.
Sounds complicated, and even a little risky? It can be. As was noted, if the other party is right about the stock in question rising in value, JPMorgan might be required to sell shares of one of more of its S&P 500 stocks the fund is holding. That's not what it wants in the long run, though. The fund's managers would rather keep all of its stock holdings all the time.
The thing is, JPMorgan might still be making that sale at a profit. It also still keeps any money collected for selling the covered call in the first place even if it's forced to fork over those shares. That's far from being disastrous.
The best-case scenario, of course, is that the call option in question expires without its buyer ever deciding to use (or "exercise") the option. This takes JPMorgan's risk off the table, freeing it up to make another similar bet, and then another, and then another, in perpetuity.
This is why selling covered calls can be a savvy way of consistently monetizing what are ultimately long-term investments. But there's a catch. More than one, actually.
The trade-off
As was noted above, every investment imposes a trade-off. JEPI is no exception. Perhaps the chief trade-off of using covered calls to generate continual income is that -- even on a net basis -- it underperforms its most relevant benchmark index.
As the graphic below plainly shows, even adding in its dividend payments funded by the sale of covered calls, the JPMorgan Equity Premium Income ETF has trailed the overall return of the S&P 500 since the fund launched back in the middle of 2020.
Blame it on the covered call strategy itself. The market has a knack for preventing anyone -- even brilliant traders -- from gaining and keeping a market-beating edge for too long. Indeed, it often punishes the effort with a subpar performance.
The other trade-off? Although the trailing dividend yield of 8.6% is compelling, the underlying dividend isn't exactly consistent. The early July payment of just over $0.40 per share is much lower than June's per-share payment of $0.54, for instance. Early this year, the monthly payment fell to just a little over $0.32. If you need this income to pay your bills, owning this fund to do it could prove stressful.
JEPI Dividend data by YCharts
In this instance, blame it on the way call (and put) options are priced. Their values are impacted by unpredictable factors ranging from market volatility to interest rates to the direction the market itself is thought to be moving. As such, sellers of these options may not always get a great price.
To buy, or not to buy?
So JEPI is a no-go as a monthly dividend investment? Well, that's not necessarily the case at all. Despite its downsides, the strong yield of 8.6% here is still attractive even if it changes from time to time. You'd probably just want to buffer its payment inconsistencies by holding other, more consistent income investments even if they offer smaller yields.
There's also at least some potential for capital appreciation with this ETF's strategy. You won't achieve as much as you might with a stake in the SPDR S&P 500 ETF Trust. But you also wouldn't be collecting the sort of dividends with the S&P 500 ETF that you would with the JPMorgan Equity Premium Income ETF, and you'd certainly see more long-term gains with this fund then you would with interest-bearing bonds. Again, trade-offs.
Bottom line? As is always the case, don't weigh potential ownership of this exchange-traded fund in a vacuum. Think about your particular needs and risk tolerances, and determine how it might fit in with the rest of your holdings. You may actually find a place for JEPI in your portfolio.
