NUSI: Understanding Their Option Strategy Is Key To This High Yield ETF

Summary

• Unlike Buy-Write ETFs that also yield over 7%, NUSI uses a combination of Selling Calls and Buying Puts to add yield and remove risk.
• Along with exploring NUSI, I cover recent option activity by NUSI to help explain how their Protective Collar Options strategy has been executed.
• For investors looking for more income, like the NASDAQ 100 Index and are willing to forego some capital gains for limiting damage when the market drops, I'm Bullish on NUSI.

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Introduction

Nationwide Risk-Managed Income ETF (NYSEARCA:NUSI) is only just short of two years old. It is structured to provide income in this low-yield environment without using Fixed Income assets that would be hurt when interest rates start to return to levels considered "normal". Their strategy is also designed to provide NASDAQ 100 exposure with less risk. The strategy used to accomplish both goals is their Protective Collar Options strategy. Understanding that is critical to appreciating what NUSI brings to the market.

For investors looking for more income, like the stocks that make up the NASDAQ 100 Index and are willing to forego some capital gains for limiting damage when the market drops over 10%, I would give the Nationwide Risk-Managed Income ETF a Bullish rating.

Reviewing the Nationwide Risk-Managed Income ETF

Data by YCharts

Seeking Alpha describes this ETF as

The investment seeks current income with downside protection. The fund is an actively-managed exchange-traded fund ("ETF") that seeks to achieve its investment objective principally by investing in a portfolio of the stocks included in the Nasdaq-100® Index and an options collar (i.e., a mix of written (sold) call options and long (bought) put options) on the Nasdaq-100. NUSI start on 12/19/19.

Source: seekingalpha.com

Nationwide and Harvest Volatility Management, the ETF manager, adds some flavor to that overview on their website:

The Nationwide Risk Managed Income ETF is designed for income-focused investors seeking to lower their exposure to market volatility and minimize the potential for losses during down markets. NUSI can be used to enhance and diversify core income-oriented portfolio allocations in the following ways:

• As a supplement to current income strategies during cycles of low or falling yields.
• As a less volatile strategy for maintaining equity exposure during volatile market periods, where the protective put options offer a degree of downside protection.
• As a strategy for managing the risk of rising interest rates and the possibility of economic recession as an alternative to a traditional bond investment.
• As a complement to a traditional 60% equity/40% bond portfolio, potentially enhancing the yield generated by the bond allocation while reducing potential volatility of the equity allocation.

Source: hvm.com

In short, NUSI is an ETF for investors looking for income but want to minimize their exposure to the bond market with where interest rates are now, and willing to give up unrestricted market gains or losses.

Holdings review

Besides the collar, NUSI owns each of the stocks in the NASDAQ 100 Index in the same proportions as the index. The top 10 stocks represent 54% of the weight.

Source: seekingalpha.com Holdings

This means liking Technology stocks in a market where many think we could be in another "Tech bubble" like before. Click here for a complete list of holdings.

Distribution review

The Fund employs a managed distribution policy which is similar in nature to comparable option-based funds. This approach allows for smoother distributions to investors. Each month the Fund seeks to pay a distribution that may be derived from a combination of option premiums, dividends, and any appreciation of the Fund's equity holdings. Most come from premiums, thus is classified as ROC.

Source: nationwidefinancial.com Form8937.pdf

Their complete payment history looks like this:

Source: seekingalpha.com DVDs

The ability to generate income from options is linked to the volatility of the assets used. Using QQQ as a proxy for the NDX options used, the November ATM volatility is about 15% for both the Calls and Puts. That will shift as market perceptions move from bullish to bearish. NUSI is apparently too new for Seeking Alpha to provide the usual ETF Dividend scorecard.

Reviewing NUSI's Protective Collar Option Strategy

Source: nationwidefinancial.com

Basically, this strategy captures income by writing Call options and some market gains, depending on how far the strike prices are OTM when written. Some of the income from the Calls is then used to buy Put options to protect the ETF from market downturns. The cost of that protection is related to level of protection desired: more protection = more cost.

I was able to locate some past option strategies which provide flavor to how the collar is used.

The 8/31/21 Annual report only showed NUSI holding 372 Puts with a strike of 14225. While searching for the Calls, I came across this, which explains why I did not see such a position.

The Fund underperformance is directly attributed to the market environment in the final days of August leading into September 2020. Immediately following the rolling of positions following August options' expiration, the Nasdaq-100® Index ("Nasdaq-100") traded higher than expected by roughly 7%. This forced the short call options to be closed per the rules-based model. This occurred as the market topped out and proceeded to sell off by roughly 10%. The long puts, despite being 4% out-of-the-money when being purchased, were then greater than 10% out-of-the-money and remained irrelevant despite the material nature of the market contraction.

Source: nationwidefunds.onlineprospectus.net (select AR)

Here are the rules used within their options strategy:

• Write covered calls on the Nasdaq-100 Index using strike prices near at-the-money or slightly out-of-the-money.
• Expiration dates within one month to guard against liquidity and duration risks.
• Call options are typically closed after a defined percentage of net premia has been generated. If the Nasdaq-100 Index rises above the strike price, the manager may close the call option early to minimize potential losses. (That is what happened in August).
• Hedges the risk of the underlying stock portfolio by buying Nasdaq-100 protective puts. Out-of-the-money puts are purchased with some of the premium generated by selling the Nasdaq-100 covered calls.

One downside of using a Collar strategy is their overall option activity could result in a loss to the ETF. The Annual report listed that option trades had lost $17.7mm over the previous year. That would be mostly from Puts expiring OTM and any Call positions being closed out at a loss.

Today, NUSI owns both Calls and Puts expiring on 11/19/21.

• Sold 480 Calls using the 15500 strike
• Bought 480 Puts using the 13350 strike

Assuming they bought these near the opening on 10/18/21 to replace the October set, NDX was trading near 15200, meaning NUSI wrote ATM Calls which allowed for a maximum gain of about $24mm and OTM Puts that would allow for a $72mm loss. Since AUM at the time was close to $720mm, it appears they over-covered their assets by $14mm, while allowing for a 10% loss in value.

When I reviewed the options listed in the 3rd Quarter report, the same coverage strategy was found: very tight Covered Calls, coupled with Puts bought allowing for a 10% drop before the Put protection started.

For more information on NUSI, read the Prospectus. The option strategy is explained in this White paper.

Portfolio Strategy

Why NUSI versus other ETFs that provide income and/or equity market exposure? Here are some reasons provided by the managers of NUSI:

Source: /hvm.com/nusi-comparison

NUSI provides a superior yield to other assets classes, except for MLPs. As we will see next, MLPs come with high risk.

Source: /hvm.com/nusi-comparison

The option strategy has successfully reduced volatility. The low beta emphasizes NUSI is not for investors looking for large market gains.

I found this chart of interest as it compares the risks of the various asset classes income investors might consider.

Source: nationwidefinancial.com

Final Thoughts

NUSI sub-2-yr history limits one's ability to draw definitive conclusions about its ability to deliver on its goals of higher yield; less volatility, but here goes. Here I will compare NUSI against two Buy/Write funds that also use the Nasdaq 100 index: Nuveen Nasdaq 100 Dynamic Overwrite Fund (QQQX) and the Global X NASDAQ 100 Covered Call ETF (QYLD).

Source: portfoliovisualizer.com

While NUSI places second in CAGR, its risk statistics are far better, showing NUSI accomplished that goal. The worst performer CAGR wise has provided the highest yield of these funds.

Source: portfoliovisualizer.com

This chart shows much CAGR NUSI investors gave up versus owning the Invesco QQQ Trust (QQQ), over 20% annually since late 2019, and that is after NUSI owners collected 7% more in income. Of course, investors aren't restricted to owning either NUSI or QQQ. The orange line shows what a 50/50 portfolio would have done. This portfolio captured 11% more upside return with little added risk. The loss of income was about half.

Source: portfoliovisualizer.com

This chart shows NUSI against the Cohen & Steers REIT & Preferred Income Fund (RNP), which combines REITS and PFD stocks and a pure Preferred stock CEF, the Flaherty & Crumrine Preferred and Income Securities Fund (FFC). Since it started NUSI has provided a better return, more income, but less risk than those two CEFs. So by accepting some equity exposure risk, investors can avoid interest-rate risk and still earn the income they seek.

For investors looking for more income, like the stocks that make up the NASDAQ 100 Index and are willing to forego some capital gains for limiting damage when the market drops over 10%, I would give the Nationwide Risk-Managed Income ETF a Bullish rating.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.