QYLD: How Has The Strategy Been Working Out?

About: Global X Nasdaq 100 Covered Call ETF (QYLD), Includes: QQQ
by: D.M. Martins Research

My concerns over a turbulent and uncertain 2019 have proven overblown so far, making buy-write strategies look less appealing.

However, QYLD yielded an impressive 10.6% annualized in 1Q19 while keeping risks well under control.

I believe this ETF continues to be well worthy of consideration, more obviously for income seekers but also for growth investors.

Back in December of last year, coincidentally only one week before the end of the 2018 "bear attack," I expressed my concerns over what 2019 could have in store for stock investors. Back then, interest rates had been rising, asset prices falling and volatility in equity prices had definitively picked up the pace.

Credit: CFA Institute

I defended that being a bit creative in putting together a more resilient portfolio for the new year could make sense. More specifically, I discussed the potential benefits of a buy-write or covered call strategy in which generating a more predictable stream of cash (in this case, from dividends and option premiums) might be more appealing than simply hoping for stock prices to rise amid so much uncertainty.

The Horizons Nasdaq 100 Covered Call (QYLD) made the top of my list of funds worth looking further into within this universe of investment strategies. As a quick recap, this is how the fund aims to create value:

  1. Buy all the equities in the Nasdaq 100 Index (QQQ)
  2. Sell Nasdaq 100 Index options that expire in one month - a premium is received in exchange for the sale of the derivatives
  3. At the end of the month, distribute a portion of the income from selling the index option to the ETF shareholders
  4. At the beginning of each new month, repeat the process

Has it been a good year for the buy-write strategy?

Fast-forward a bit over one quarter since my last QYLD article (and a 17% market value increase in the Nasdaq 100 index), the macro landscape is now looking much quieter. The graph below illustrates how volatility in equities has lowered substantially in 1Q19 as stocks have regained their footing.

Source: DM Martins Research, using data from Yahoo Finance

Such an environment is much more friendly to equity ownership. In hindsight, it is easy to say that having plainly invested in a stock index in 2019, at least up to this point, would have been wiser than using the more cautious approach of a covered call strategy. The graph and table below show that QYLD has produced less than half as much return YTD than the fast-recovering, tech-rich Nasdaq index. Even on a risk-adjusted basis, and despite having created significantly less volatility, QYLD has noticeably lagged the performance of QQQ this year.

Source: DM Martins Research, using data from Yahoo Finance

However, I would also argue that comparing QYLD against a strong, bullish market will always be a bit unfair. So far this year, the benefits of using a more conservative buy-write investment approach have not surfaced. But being prepared for the less-than-ideal scenarios is an important tenet of prudent investing.

That said, I believe QYLD continues to be an ETF well worthy of consideration, more obviously for those looking to receive a steady stream of income. In the first three months of 2019, Horizon's covered call fund made distributions equivalent to an annual yield of 10.6%, which is certainly respectful. Less obvious, even growth investors could still benefit from dipping their toes in the buy-write space, as some evidence suggests that the approach could be superior at producing materially better-than-market average absolute and risk-adjusted returns over time (see table below). Source: CBOE

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.