Like a great two-person beach volleyball team, the covered call segment of the ETF space did the “set” and YieldMax ETFs did the “spike.” That’s another point for investors who like their ETF income the way many like their paychecks: weekly.
In a Wednesday press release, YieldMax did to its base of nearly 100 option-income ETFs what Democrats in the U.S. Congress are longing to do about 13 months from now: Flip the majority. YieldMax is about to convert the vast majority of its monthly distribution funds to a weekly pay structure. Like a paycheck. Or for those who get paid every two weeks, better than a paycheck.
YieldMax is not the only producer of weekly pay covered-call ETFs. But the firm has become a go-to for Baby Boomers and others who crave ways to replace what used to be an actual, scheduled receipt of earned income. The difference for many now is that they don’t work to make that income. They saved prudently, invested well, and now direct their assets as they wish, in retirement.
For some, YieldMax took a longstanding concept, covered call writing, and kicked it up a notch. How? By using “credit spreads” to take what is already high yield potential available by sacrificing much of the upside of the underlying stock, and adjusting the ETF’s structure to pump out more yield.
Per YieldMax:
“Instead of only selling a call, you also buy a higher strike call. This creates a call spread, which lowers your premium income but limits the risk of capped gains if the stock surges.”
This increases upside, but does not reduce downside risk by a significant amount in most cases.
How Do YieldMax ETFs Differ From Options Collars?
As I’ve discussed here frequently, covered call writing on stocks and on ETFs is one half of an option strategy known as a “collar.” I’ve also expressed my strong opinion that while it is nice to see that pile of cash generated from writing calls and daring the market to take your stock away at a higher price (that’s the tradeoff), this is far from a risk-free endeavor.
More accurately, it is only as good as the underlying stock’s performance.
That’s why I write about how taking the extra step of buying a put option on the same stock, to complete the collar, is often a worthy consideration.
Don’t get me wrong, I get the appeal of these vehicles and I think YieldMax has done a fine job of bringing a value-added product line to the masses via its ever-growing roster of ETFs. My concern is not with the firms involved in getting YieldMax to its market leadership position.
My red flag is simply this: Based on the history of modern investing, we know that investors are prone to sinking big sums of savings into funds based on their “offensive” features. But many do so without paying at least as much attention to the ETF’s ability to play “defense.” If it does at all.
A couple of years ago, when YieldMax was just starting to proliferate its product line, I spoke at some length with members of the trading team there. They explained that a reasonable assumption was that the structure YieldMax employs with most of its funds could be expected to earn about 80% of the upside of the underlying stock and incur about 80% of the downside. That’s not every time with every stock, but more of a proxy. Similar to a “capture ratio” projection.
What’s the Biggest Risk of Covered Call ETFs?
My question is: What portion of holders of covered call ETFs from any provider (YieldMax included) would be surprised if one of their ETFs fell by, say, 50%, primarily because the underlying stock cratered by 60%? It has happened before, but the markets recovered quickly. And, so did covered-call ETFs.
And if that doesn’t happen? That is, we get something more like 2000 or 2008. I don’t know the answer, but I also would not bet against the next financial market crisis including a lot of network TV segments devoted to what “no one saw coming.” That is one of the lessons of past bear markets.
All we can do for now is note the potential risk. And, the fact that weekly covered call writing is unlikely to change such a worst-case scenario much, versus getting paid monthly from these ETFs.
Getting paid with your own money, so to speak, is OK with investors for a little while. But not for the longer term.
