QYLD: 15% Yielding Tech ETF With A Catch

Summary

  • The Global X Funds - Global X NASDAQ 100 Covered Call ETF offers a hefty double-digit income yield, made possible by its unique approach of selling covered NASDAQ calls.
  • The strategy limits QYLD's appreciation potential severely, however. QQQ has been a better total return pick despite a much lower yield.
  • QYLD is an income pick primarily but might also be a solid total return pick for swing traders.
  • Looking for a helping hand in the market? Members of Cash Flow Club get exclusive ideas and guidance to navigate any climate. Learn More »

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Baris-Ozer

Article Thesis

The Global X Funds - Global X NASDAQ 100 Covered Call ETF (NASDAQ:QYLD) is a high-yielding vehicle that generates a massive 15% dividend yield by selling covered calls on the Nasdaq 100 index. For income investors, that can be quite tempting -- but investors should note that QYLD doesn't offer the same upside potential as other tech investments, including the Nasdaq index itself (QQQ). Over the years, QYLD has lost principal, although buying at the lows has worked well in the past -- we might have such a buying opportunity right now, with the QYLD ETF down more than 20% year-to-date.

Tech Generally Doesn't Offer High Yields, But QYLD Does

Tech stocks generally offer below-average dividend yields. Many of these companies are in a high-growth phase where they reinvest their cash flows to push user growth, subscriptions, etc. That limits their shareholder return potential. On top of that, there's an array of tech stocks that aren't profitable yet -- paying a dividend under these circumstances makes no sense.

Even among the profitable companies, many tend to trade at high valuations, which generally goes hand in hand with lower dividend yields. If, for example, an energy company pays out half its net profits while trading at a 10x earnings multiple, that makes for a 5% dividend yield. If a tech stock trades at 30, 40, or 50x net profits while paying out half its earnings via dividends, the dividend yield is much lower. It's thus not surprising to see the broad tech industry (XLK) offer a dividend yield roughly half as high as the broad market's (SPY) ~1.5% dividend yield. Even major tech companies that offer dividends, such as Microsoft (MSFT) or Apple (AAPL), oftentimes have dividend yields in the sub-1% range.

At first sight, an ETF such as QYLD that combines tech exposure with a hefty dividend yield of 14.9% thus looks very intriguing. Not only is the dividend yield very high in absolute terms, but the tech industry is oftentimes seen as a sector one can look to for capital appreciation potential. In general, that's true, although that is not really the case with QYLD.

The Global X Funds - Global X NASDAQ 100 Covered Call ETF does not offer comparable upside potential to a traditional Nasdaq/tech-focused ETF, such as QQQ. That becomes very clear when we take a look at the past performance of these two ETFs:

QYLD price and return
Data by YCharts

The Covered Call ETF has seen its price decline by 29% over the last decade, while the QQQ ETF has seen its price climb by 270% over the same time frame. When we account for dividends/distributions, the difference is smaller, but still pretty wide -- the Covered Call ETF has delivered returns of ~6% a year, while the Nasdaq index as a whole has delivered returns in the 15% range. Clearly, going for the QQQ ETF was the better choice over the last decade, despite the fact that dividends are way smaller here -- QQQ yields just 0.6% today.

This big discrepancy between QYLD's yield advantage and its much smaller total returns can be explained by the way it generates its yield. QYLD sells covered calls on the Nasdaq 100. Selling covered calls, no matter whether the underlying is an ETF, stock, or index, generates proceeds through the option premiums that the seller of the call option receives from the buyer of the call option. These option premiums are then used to pay QYLD's hefty dividends at a current level of $2.65 per year, which translates into a yield of 14.9%.

Selling covered calls has a downside, however, as these option premiums aren't generated for free. Instead, sellers of covered calls limit their upside potential, as shares are getting called away when they rise above the strike price of the option that has been sold. For individual investors, that means that they might have to re-buy their positions or find other investments. In QYLD's case, it means that the upside in the Nasdaq 100 does not materialize for QYLD's owners -- instead, price gains in the index land in the pockets of the buyers of the calls that QYLD sells. When the index drops, QYLD drops with it -- but when the Nasdaq 100 rises, QYLD only barely rises with it, as its upside is limited due to the covered calls it has written/sold. In short, that's why QYLD manages to generate a hefty yield despite its tech exposure, while at the same time, this is the reason for QYLD's lacking appreciation even during times when the Nasdaq index is running higher -- as was the case over the last decade.

In general, these mechanics won't change going forward. Investors can thus expect that QYLD will continue to generate appreciable income via its call selling strategy. At the same time, QYLD will continue to underperform appreciation-wise, relative to the Nasdaq index itself, as price gains in the index are not completely ending up in QYLD's pockets. Instead, some of those gains are captured by the option holders QYLD has sold covered call options to.

Timing Makes A Difference

Over the last couple of years, QQQ has thus easily outperformed the higher-yielding QYLD ETF. That being said, QYLD has offered some potential to investors when they bought following steep plunges:

QYLD price drop

YCharts

In the past, QYLD has experienced steep and abrupt drops from time to time, e.g. at the end of 2018 and in early 2020. In both cases, this was at a time when broad markets experienced downturns. In 2018, that was driven by rate hike fears, while the market's price drop in early 2020 can be attributed to the COVID-induced selling pressure. In both cases, QYLD recovered quickly, rising by double-digits in a couple of months.

Right now, QYLD is again trading at a rather low price, following a steep plunge over the last couple of months. There is, of course, no guarantee that there will be a swift recovery this time as well. But the ETF's history suggests that it generally is a good time to buy into QYLD following these plunges -- whereas it is not a great time to buy into the ETF when it has recovered from the most recent drop. Whether there is a major recovery this time is not known, but I do believe that right now is likely a better time to buy compared to half a year or a year ago, when QYLD was trading at a substantially higher price. This also has an impact on QYLD's dividend yield, which is currently at an above-average level, following the most recent price drop:

QYLD Dividend Yield
Data by YCharts

Compared to the last decade, QYLD's trailing twelve months yield of 12% is at the high end of the trading range -- the yield ranged from 7% to 13% in the past. Note that YCharts calculates QYLD's dividend different than Seeking Alpha -- Seeking Alpha notes $2.65 per share in payments over the last year, which translates into a 14.9% yield at current prices, whereas YCharts does not include the big one-time payment in December 2021, at $0.49 per share. But even when we back that out and look at the 12% yield as calculated by YCharts, that would make for a hefty income yield based on QYLD's current trading price.

What To Make Of QYLD

I'm a total return-focused investor, which is why I do not look at income yields in a vacuum. QYLD undoubtedly has a hefty income yield, but the fact that it's lagged the NASDAQ in total returns due to its share price actually going down over the years is important.

Swing trading has worked solidly in the past, as buying QYLD following steep and sudden drops allowed for a huge monthly income yield while also offering some appreciation potential. Investors should note, however, that there is no guarantee that this strategy will continue to work.

Total returns have not been too bad here, but worse compared to a simple tech ETF like QQQ. That's why I do not see QYLD as a good long-term buy and hold pick. But for income investors needing or wanting a big yield, QYLD might have some merit, while it also could work for a more active swing-trading approach of buying the drops and selling the following recovery.

Is This an Income Stream Which Induces Fear?

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This article was written by

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Author of Cash Flow Club
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Disclosure:

I work together with Darren McCammon on his Marketplace Service Cash Flow Kingdown.

Disclosure: I/we have a beneficial long position in the shares of MSFT either through stock ownership, options, or other derivatives. 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.

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