XDTE: An interesting spin on covered call funds

There are two investment themes that have dominated the retail mindset. The first is the extremely high yield. The second is 0 Days to Expiry Options (0DTE). Those 0DTE options have exploded in popularity. Roundhill understands both of these dynamics, which This is why they were the first to launch a 0DTE covered call fund in the Roundhill S&P 500 0DTE Covered Call Strategy ETF (BATS:XDTE). The idea is to actively provide exposure to the S&P 500 overnight while simultaneously selling out-of-the-money 0DTE calls each morning. Covered call strategies like this have been all the rage as they generate juice. But there is a twist here where the fund makes its payments weekly.

Interesting twist on things. Go? Or would you be better off simply owning the S&P 500?

Analysis of holdings

The fund achieves its exposure through options, as we can see from its top holdings. The synthetic nature of the strategy allows Roundhill to gain exposure to the S&P 500 without holding it.

Peer comparison

XDTE stands out by addressing 0DTE covered calls. There are other covered call ETFs, such as the Global X S&P 500 Covered Call ETF (XYLD). But XDTE’s focus on 0DTE options makes it different. Typical covered call ETFs often write monthly or weekly options, but XDTE takes a daily approach. This allows it to collect premiums more often and offer higher distribution rates. As of August 31, 2024, the fund had a distribution ratio of 25.93%, which is much higher than many similar funds. However, note that the 30-day SEC yield is -0.46%. This suggests that the high distribution rate may not be supported by the fund’s income and may include returning some of the investors’ capital.

When we look at the price ratio of XDTE to the S&P 500 (SPY), we see that it has outperformed since July. That makes sense given the stock’s volatility since then. If you think the markets will continue to be vulnerable, then XDTE becomes a good way to hedge a bit on the downside, as selling covered calls becomes more beneficial as a loss buffer.

Pros and cons

In addition, the fund offers you a unique way to earn a lot of current income. The 0DTE covered call approach allows you to collect premiums often. The fund tracks the S&P 500 so you can still benefit from market gains to some extent. This approach could also help protect you when markets fall. When stocks go down, the money you make from writing calls can help offset some losses in your index stake. This could mean fewer ups and downs compared to investing in the S&P 500 index.

Problem? The high payout rate looks good, but it might not last forever. The negative 30-day SEC yield tells us that some of the money paid out might actually be investors’ own cash, not real earnings. This means that you could get some of your investment back as ‘income’. This can affect your taxes and could shrink the size of your fund over time if your investments don’t grow enough to compensate. Additionally, the 0DTE strategy, while profitable, comes with its own set of risks. The rapid time decay of 0DTE options can benefit the fund, but it also needs accurate timing and execution. Another potential downside is the fund’s capped growth potential in bullish markets. While the strategy provides some exposure to the market, the continuous writing of call options limits possible gains. In a rapidly rising market, the fund may not perform as well as a direct investment in the S&P 500 Index.

Conclusion

The Roundhill S&P 500 0DTE Covered Call Strategy ETF is certainly unique, enabling a new way to generate income in the ETF world. His approach of writing daily covered calls on the S&P 500 provides the chance for high current income. However, the complexity of the strategy, the chance to get capital back in distributions, and the limiting upside in strong bull markets are things investors need to think about. In fact, I think the fund may do quite well relative to the broader S&P 500 in the coming months, given my own views on volatility and downside potential. Worth considering.

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