YMAX ETF: Strategy Weakness Full Screen

In April, I wrote a cautionary piece about the YieldMax Universe Option Income ETF Fund (NYSEARCA: YMAX), warning readers that although the YMAX ETF had strong returns of the gate and paid a very high distribution yield, investors are still exposed to the fundamental flaw of the covered call option strategy, namely, upside down/unencapsulated down.

Since my article, YMAX’s returns have taken a turn for the worse as some simple stocks in the YMAX portfolio have taken a nosedive, leaving YMAX’s stock price down 22% in a matter of months (Figure 1). Fortunately, the YMAX ETF was still able to collect premium income during this time, so total returns were less disastrous at -8%.

With 8 months of operational history, I I think we can start to draw some conclusions about YMAX’s strategy and performance.

In my opinion, YMAX’s strategy of buying a portfolio of hedged funds is not the same as buying a hedged loan on a diversified stock portfolio. In the latter case, a diversified stock portfolio is largely uncorrelated, and the risks associated with a single stock cancel out. However, in YMAX’s case, the fund basically makes bets on 22 individual stocks each month using covered calls.

When the bets are “correct”, the covered call limits for a single stock are up. When the bets are “wrong,” the hedged stock loses almost as much as the underlying stock. This is a long term the loser’s game.

Brief overview of the fund

The YieldMax Universe Fund of Option Income ETFs is a “fund of funds” of single-stock YieldMax ETFs. YieldMax has been very successful in raising capital with the lure of high double-digit yields, with the YMAX ETF now having more than $240 million in AUM, more than double the figure from April (Figure 2). YMAX charges a management fee of 0.29% in addition to the 0.99% management fee charged by the underlying YieldMax Single Equity ETFs.

To understand the flaw in the YMAX strategy, we must first explain how the YMAX ETF and the YieldMax ETFs with underlying single stocks are constructed.

All single-stock YieldMax ETFs have the basic structure of holding synthetic long (call long/short put) single-stock exposure, such as Airbnb Inc. (ABNB) in the YieldMax ABNB Option Income Strategy ETF (ABNY) or Apple Inc. (AAPL) in the YieldMax AAPL Option Income Strategy (APLY) ETF.

In total, YMAX holds 22 such single-stock ETFs, although in addition to the YieldMax MSTR Option Income Strategy (MSTY) ETF, YMAX appears to hold additional MSTR calls and puts (Figure 3).

Against synthetic long exposure, each single-stock YieldMax ETF will write short-term call options to “harvest” option income using a “covered call” strategy. For example, in the ABNY ETF, the synthetic long on ABNB is created using options expiring October 2024, while the fund wrote weekly options expiring on September 24 to generate income (Figure 4).

Unlimited upside/downside is the main flaw

By itself, the covered call strategy is not necessarily bad, as it mainly trades the stock’s growth with the proceeds of the forward option premiums, while retaining most of the downside of owning the stock.

Many successful income funds such as the JPMorgan Equity Premium Income ETF (JEPI) use the covered call strategy to provide thousands of investors with a steady monthly income.

However, over the long term, the covered call strategy is likely to underperform because it generally cannot keep up with the total returns of an uncapped stock market as stocks rise over the long term (Figure 5).

The problem I have with YMAX is that YieldMax pushes the covered call strategy to the extreme by implementing it on single stocks. While a broad basket of stocks, say the S&P 500 index, is highly unlikely to fall more than 30% in any given year (unlikely, but it does happen from time to time!), single stocks can rise and typically drop 30-50%.

For example, ABNB shares have collapsed by 30% in recent months (Figure 6).

ABNY, a hedged call fund on ABNB, is down 18% since its inception in June, compared to a -24% decline in ABNB shares, or a ~75% decline capture (Figure 7).

On the other hand, when single stocks rise, they do so in a non-linear fashion, and short-term bull selling can cause significant underperformance. For example, AAPL stock is up 13% over the past 3 months, but the APLY ETF is only up 6% because it sold off AAPL stock, or a 46% capture (Figure 8).

By focusing on a portfolio of highly volatile stocks such as Coinbase (COIN), MicroStrategy (MSTR), Nvidia (NVDA), and ABNB, the YMAX ETF can set investors up for underperformance because it basically does a series of risky bets every month. .

When his bets are “right” and the stock goes up, say ABNB goes up 10% after a good earnings report, the YMAX ETF (by holding ABNY) will underperform because it has sold up. On the other hand, when it’s “wrong” and ABNB drops 10% after a bad earnings report, the YMAX ETF (through ABNY) will drop ABNB almost as much.

This is a losing game in the long run because individually each of these covered positions is akin to a roulette player going to a casino and betting on red. Because the odds are stacked against the gambler (i.e. the covered call is skewed toward underperformance with more downside than upside), then on average an investor (ie YMAX) who makes many of these bets in a portfolio will become net losers as a single slip-up can cause significant losses to the fund (i.e. the losing game).

Comparing YMAX to established income funds

With 8 months of trading history, we can also begin to compare the YMAX ETF to more established income funds such as JEPI, the JPMorgan Nasdaq Equity Premium Income ETF (JEPQ), and the Global X NASDAQ 100 ETF Covered Call (QYLD). In terms of fund structure, YMAX is by far the most expensive, charging an all-in expense ratio of 1.28%, compared to 0.35% for JPMorgan products and 0.61% for QYLD (Figure 9).

The main attraction of YMAX is its attractive distribution yield, with an annualized distribution yield of 42.4% based on the most recent annualized distribution. This is much higher than JEPI (7.3% after 12 months), JEPQ (9.9%) and QYLD (12.0%) (Figure 10).

However, in addition to looking at YMAX’s yield, investors need to consider total returns. A high yield with a falling share price means that the total return to investors can be much lower (Figure 11).

Comparing total returns since YMAX’s inception in January, the YMAX ETF has only delivered a total return of 4.8%, compared to 9.7% for JEPI, 8.8% for JEPQ and 6.3% for QYLD (Figure 12) .

Figure 12 also shows that the YMAX ETF appears to have the most volatility, with total fund returns collapsing in recent weeks as equity markets face a pullback.

Overall, I think YMAX is a bull market income fund that can only be suitable when the markets are rising and each stock is rising in a correlated fashion. In this scenario, YMAX should offer a high return on option premiums, while its NAV will not shrink due to single share declines.

When markets are more volatile and single stocks rise and fall in an uncorrelated manner, the YMAX single stock covered call portfolio may not perform as well as a covered call on a diversified single stock portfolio (i.e., JEPI) because the loser’s game the nature of his strategy.

Conclusion

The YieldMax Universe Fund of Option Income ETFs posted total returns of -8% over the past few months as equity markets pulled back and individual stocks fell.

Without the tailwind of a bull market, the flaw in the YMAX strategy was on full display. A portfolio of covered calls on a single stock is not the same as a covered call on a diversified portfolio of stocks.

In a diversified portfolio of stocks such as the S&P 500, the idiosyncratic risks are uncorrelated and cancel out, so a covered call strategy for this portfolio faces primarily market risk.

On the other hand, YMAX makes 22 single-stock hedged bets, each of which faces both single-stock risk and market risk. In the long run, this is a the loser’s game strategy because a single bad catalyst from one of the 22 stocks can lead to significant losses for the fund, while a positive catalyst will be capped by sold call options. I continue to recommend that investors avoid the YMAX ETF.