This Nvidia ETF has a 77% dividend yield, but should you buy Nvidia stock?

The YieldMax NVDA Option ETF Income Strategy (NVDY -0.17%) has received quite a bit of attention from investors recently, and it’s not hard to see why. Not only does it provide exposure to Nvidia (NVDA -1.92%)which is arguably the most popular stock on the market right now, but it also offers dividend income and many from her. In fact, as of this writing, the ETF has an incredible dividend yield of 77% based on the last 12 months of payouts.

Of course, there is no such thing as a completely guaranteed 77% annual return on any investment, so there are a few things that are important to know before investing. Here’s an overview and whether you’d be better off buying Nvidia stock instead.

How the ETF invests your money

It might surprise you to learn that the YieldMax NVDA Option Income Strategy ETF doesn’t actually own any Nvidia stock. It puts your money into Treasuries and uses them as collateral to create income-generating option spreads. Fund managers will typically do a combination of buying and selling calls and puts to create the desired income and exposure to share price changes.

The overall effect is that:

• If the share price rises gradually, the NAV of the fund will increase over time. This is the best case scenario when selling covered calls in general.
• If the stock is flat or falling, the fund’s NPV will fall but likely outpace the price action of the underlying stock.
• If the stock rises rapidly, as Nvidia did, the fund’s NAV will rise over time, but it will underperform the stock, often by a significant margin.

Income is not constant

One important thing to know is that even if the ETF performs well, it is not likely to be a consistent income generator for you. In fact, since the fund’s inception in May 2023, monthly dividend payments have been as low as $0.415 and as high as $2.6219. That’s a six-fold difference. And there is absolutely no way to know how much income you will make from month to month.

What the graphs tell us

When it comes to covered call strategies, whether it’s an income ETF like this one or if you’re simply writing covered calls in your own portfolio, a general rule of thumb is that when the underlying stock doesn’t indeed well, you’re going to underperform it.

That’s exactly what happened with Nvidia. Over the past year, Nvidia stock is up 166% as increased investment in AI has been a massive tailwind for the business. On the other hand, even including its massive dividend yield, the YieldMax NVDA Option Income Strategy ETF is up about 105%. That’s 61 percentage points of underperformance.

NVDY Total Return Price data by YCharts

Should You Buy Nvidia Stock Instead?

Before you decide to invest in the YieldMax NVDA Option Income Strategy ETF, there are a few things to consider.

First, don’t expect an 80% return in the next 12 months. It certainly could happen, but a look at ETF dividend history shows that investors have received disproportionately large payouts in months when stocks have risen, causing option premiums to be high. YieldMax ETFs on stocks that have been less volatile are generally in the 30% range. Now, a higher return could happen, but it would probably only happen if Nvidia either rose higher or dropped like a rock.

Second, the share price of the ETF itself may decline over time. Nvidia’s price action over the past year, which has been up almost all the time, is an ideal scenario for the share price of a covered call ETF, and all it could manage was a 5% gain. To be sure, a flat to slightly declining ETF share price combined with a dividend yield up to double digits can still be a very good total return, but take into account the nature of the long-term decline. As a suggestion, I would probably skip the automatic dividend reinvestment with this one, as I would like to limit my position in a stock that is destined to decline over time.

As a final thought, YieldMax ETFs like this one work best during periods when a stock is growing over time, but gradually. If you think Nvidia’s period of rapid stock price growth is behind you and you have a high tolerance for risk, a small position in the YieldMax NVDA Option Income Strategy ETF might make sense. But if you want to be a long-term investor in Nvidia stock, there’s simply no better way to do it than simply buying Nvidia stock.