What makes stocks or exchange-traded funds (ETFs) fall into the high-yield category is often subjective among market participants, but what's not up for debate are the paltry yields on some of the most widely followed domestic equity indexes.
For example, the largest ETFs tracking the S&P 500 and the Nasdaq-100 indexes feature distribution rates of just 1.06% and 0.44%, respectively. Those aren't high hurdles to clear, making it relatively easy to identify ETFs that fit the bill as big yielders. But some funds really ratchet up the income proposition.
This unique ETF includes a massive dividend. Image source: Getty Images.
One example is the NEOS Nasdaq-100 High Income ETF (QQQI 1.62%), which sports an eye-catching distribution of 14.28%. No doubt that's tempting, but there are other reasons why this ETF is on my December radar.
How this ETF generates income matters
As noted above, the Nasdaq-100 index isn't going to win any medals in the high-yield dividend competition, and the income ETF we're discussing features that index's name right in its title. So what gives? How does the $5.98 billion NEOS fund earn its rightful place in the high-yield dividend ETF conversation?
The answer boils down to the ETF's status as a covered call product. The ETF's management team sells call options on an index that often sports high premiums, allowing the fund to harvest an impressive income crop. Hence that tidy yield.
Undoubtedly, the NEOS ETF could be appealing to a broad swath of income-hungry investors, but there's even more to like with the fund. Some of that is attributable to the fact that it doesn't sell calls on the Nasdaq-100. It also buys some bullish options contracts, implying there's upside potential. It's crucial to address this, as covered call ETFs typically limit upside potential for big yields.
NASDAQ: QQQI
Key Data Points
Granted, the NEOS ETF's real-time history isn't extensive -- it debuted on Jan. 30, 2024 -- but its total returns through Sept. 30 have easily outpaced those of rival covered call ETFs linked to the Nasdaq-100. Since inception, this income ETF has even stacked up pretty well against basic funds tracking that tech-heavy gauge.
Powell makes me like this ETF even more
"You're a mean one, Mr. Grinch" is sentiment that may now be applicable to Federal Reserve Chair Jerome Powell, who on Oct. 29 triggered a late-day sell-off in stocks by pooh-poohing the idea that a December interest rate cut is guaranteed.
Erring on the side of caution and assuming the Fed doesn't deliver a rate cut around the holidays is all the more reason to like the NEOS ETF because unlike a typical high-yield dividend ETF, which is likely loaded with stocks hailing from rate-sensitive sectors, this fund isn't overly vulnerable to Fed disappointment.
On a related note, the NEOS ETF could complement bond-heavy portfolios because bonds and fixed-income ETFs are sensitive to Fed news. Oh yeah, this income ETF also features monthly distributions, just as most bonds do.