If Wall Street’s love affair with Nvidia ends, this ETF could be toast

When the first thing an exchange-traded fund (ETF) puts on its website is a list of caveats, well, you should probably pay attention. And a list of warnings is exactly what you’ll find at the top left of the Yieldmax NVDA Option ETF Income Strategy (NVDY 0.74%) product information page. Unfortunately, what appears on the right is likely to get a lot more attention — a distribution yield of 77%! This is not a typo. However, there is a lot to think about before buying this ETF.

What warning does Yieldmax NVDA have for investors?

When dealing with risky investments, the Securities and Exchange Commission (SEC) usually requires a product sponsor to explain the risks so that investors can clearly understand what they are getting into. Normally, however, these risks are not placed first and are often buried in a prospectus. The NVDA Yieldmax ETF took a radically different approach. Right at the top of its production information site, it explains:

The fund does not invest directly in NVDA.

Investing in the fund involves a high degree of risk.

Single issuer risk. Issuer-specific attributes may cause an investment in the Fund to be more volatile than a traditional mutual investment that diversifies risk or the market in general. The value of the Fund, which focuses on an individual NVDA, may be more volatile than a traditional mutual investment or the market as a whole and may perform differently from the value of a traditional mutual investment or the market as a whole.

The Fund’s strategy will limit its potential gains if NVDA shares increase in value. The Fund’s strategy is subject to all potential losses should the value of NVDA’s shares decline, which cannot be offset by the income received by the Fund. The Fund may not be suitable for all investors.

The Fund’s shareholders are not entitled to any dividend paid by NVDA.

That’s a list! You really need to understand what’s going on before you get drawn into the ETF by its 77% distribution yield. This return, by the way, is listed in large font right across from the risks (with dramatically smaller font), which may cause some to overlook the really important information. You guessed it: the important information is not the return, but the risk.

Basically, the sponsor is telling you that Yieldmax NVDA security is shockingly risky. That’s in part because it only tracks one stock. But then an options strategy is added, which increases the complexity. And further down the page, you’ll find that you’re paying an expense rate of 0.99% for the privilege of taking on all that risk. This is a very high expense ratio for an ETF.

I’m thinking a bit about this ETF

So what’s really going on here? The ETF owns a bunch of bonds and then buys and sells options on stocks of Nvidia (NVDA 1.92%). The purpose of the fund is to generate current income, with a secondary objective of seeking “exposure to the price of the common stock of NVIDIA Corporation (NVIDIA), subject to a limitation on potential investment gains.”

Basically, since the ETF doesn’t own any Nvidia stock, it’s dealing with empty options (which just means it doesn’t own any of the underlying stock). Selling not call options (which gives the call buyer the right to buy shares and forces the option seller to deliver/sell them) can generate income, sure, but the risk is that the stock goes up and the option has to be bought back at a price higher because it is likely to be exercised. To deal with this risk, the ETF buys call options that have a higher price (and usually a lower cost) associated with them. Essentially, he will make money from the increase in the value of the call options he buys, and that will offset the losses he experiences on the call options he sold.

Sound complex? It is and is not the only problem with the fund. This is not an investment you should own unless you have a very good understanding of options and the options strategy of the Yieldmax NVDA ETF. You have to spend a lot of time reading the prospectus, which unfortunately many investors don’t bother to do. The only investors who should buy this are people who would use this strategy themselves (perhaps because they own Nvidia stock) if they had the time, but would rather pay someone else to do it for them.

Here are more issues to consider: Volatility is often a good thing for options traders because it creates the opportunity to buy and sell at bargain prices. So Nvidia was a pretty attractive stock to use for this approach (there are other YieldMax ETFs that use different stocks). However, that volatility will carry over to the income actually generated by the ETF, as some months will be better than others for executing the strategy. To get an idea of ​​this, just look at the $1.2512 per share in dividends paid in August 2024 and compare that to the $2.4707 paid in July 2024. You won’t get a consistent income stream here, which which will probably stop investors trying to get income. they live off their dividend payments.

Part of the problem is that Nvidia stock has taken on fad status and can be very volatile. This adds to the risk equation, as Wall Street fads often come to a painful end. And here’s an interesting thing: If demand for the ETF drops too much, the sponsor will likely close the fund. So, you may end up taking a risky investment approach to generate income only to have that income disappear without a chance of recovery. Oh, and as the sponsor noted, “The fund’s strategy is subject to all potential losses if NVDA shares decline in value…” In other words, before the ETF is closed, you may have to endure a important issue. capital loss.

The risks outweigh the rewards

The Yieldmax NVDA Option Income Strategy ETF does something very specific, and frankly, it’s not going to produce a steady stream of income for investors. Most dividend investors, and especially conservative ones, would be better off avoiding it. Huge returns can be enticing, but the risks associated with that return are too great. This is a specialized ETF for a specialized clientele.