QQQY: This fund’s best income payouts should come in the next year

Most investments are at least somewhat cyclical. While there are some companies that have recession-proof business models, most markets will go through different phases depending on various factors.

With inflation levels being elevated for the most part the last 3 years, prices still high and interest RATES at levels not seen in 22 years, many dividend investors are finding it harder to find solid, consistent income. A new form of investment that has become increasingly common over the past few years are covered call funds focused on making regular monthly payments.

A fund that has recently entered the market in the past year that uses covered calls to generate income is the Defiance Nasdaq 100 Enhanced Options Income ETF (NASDAQ:QQQY). This exchange-traded fund sells 5% in-the-money put options to make monthly payments. The the fund invests the money received from the sale of options in low-risk income-generating financial instruments such as government bonds.

QQQY has provided investors with total returns of 14.86% since the fund’s inception in September 2023. The Nasdaq 100 Index in which this fund invests has provided investors with a total return of 26.88% over the same time frame.

We initiated coverage of the Defiance Nasdaq 100 Enhanced Options Income ETF in April of this year and rated the fund a buy. I’m upgrading my coverage on this exchange-traded fund to a strong buy today. The main factor that determines the monthly income that QQQY can pay is the implied volatility premiums on the put options that this fund sells on a monthly basis.

QQQY HAS an expense ratio of 0.99% and the fund has $201.5 million in assets under management. The ETF has a 30-day SEC yield of 4.58%. While the Nasdaq 100 can obviously experience high levels of volatility, the index is not likely to sell off hard for several reasons. Many of this index’s largest holdings are companies that have proven to be only moderately cyclical, such as Microsoft (MSFT), Amazon (AMZN), and Costco (COST). No holding in this index also accounts for more than 9% of the fund, and the Nasdaq 100 also has significant communications, healthcare and consumer defensive holdings. This is a well-diversified index that has only moderate exposure to more cyclical industrial and consumer-based companies, the Nasdaq 100 is not likely to experience excessive levels of volatility in the current economic environment.

However, even though this is a well-diversified fund, the Nasdaq 100 is likely to experience high levels of volatility going forward. The VIX had been near a 10-year low for some time before starting to rise recently as markets became more volatile with growing signs that levels of consumer spending, which comprises nearly 70% of US GDP, are starting to lose weight significantly. The Nasdaq 100 should also hold up quite well even in a weak market for several reasons if volatility levels rise.

QQQY’s monthly payouts have varied widely from $0.62 per share in January 2023 to $1.10 per share in October 2023. The implied volatility levels of the monthly put options that this fund sells have an impact significantly on the regular payouts that QQQY can make, and put options tend to be more volatile than call options.

QQQY’s goal is to be able to return to investors at least 0.25% of income per day.

All investments have risks, and this fund uses a higher-risk options strategy because the downside potential is unlimited when shorting the ETF, while upside gains are limited because the exchange-traded fund can only gain as much money per month from the options strategy as the value of the put options sold. This fund is likely to continue to underperform the Nasdaq 100 that the ETF focuses on, as well as the broader indices, and QQQY has seen its net asset value decline by nearly 34% over the past eleven months from establishment of the fund.

QQQY has one of the first funds to focus on selling puts rather than calls to generate income, and this ETF’s strategy should provide investors with consistent and significant income without the high level of volatility. Also, this fund will perform ideally when volatility levels are rising but not to a point where the risk to principal is excessive and these are the current conditions that exist in the markets today. While this fund will be for investors comfortable with an above-average risk profile, this ETF should provide solid and consistent returns in the current investment environment over time.