Indexes

A Simple, High Yield Strategy for Income Investors

The Decade of the Nasdaq-100

Central bankers have talked consistently about a strengthening economy while reaffirming plans for interest rate hikes. The market's appetite for risk is coming back and growth indexes, especially the Nasdaq-100, are performing very well this year. Despite the recent selloff due to richness, the fundamental picture of Nasdaq-100 has not been changed and the long term performance of Nasdaq-100 is consistently beating other major, large cap equity market indexes (Figures 1 & 2). The underlying story for the rise in the Nasdaq-100 is that the U.S.'s economic growth is shifting from the traditional industries (Basic Materials and Oil & Gas) to the newer sectors (Health Care and Technology) (Figures 3 & 4).

A Structured High Yield Nasdaq-100 Index

Growth strategies can require a long holding period in order to outperform, and are often eschewed by income investors, who prefer regular dividend distribution. The Nasdaq-100 index is currently paying a 1.2% annual dividend. While growing significantly, it is too low to meet many income investors’ needs. Income investors may consider integrating the CBOE NASDAQ-100 Buy-Write V2 Index (BXNT) into their current portfolio to boost their regular income payments. The CBOE NASDAQ-100 Buy-Write V2 Index measures the performance of the NASDAQ-100 Index plus the written (or sold) call options on the NASDAQ-100 Index. Buy-Write (or covered call) is an investment structure used to enhance risk-adjusted returns and reduce volatilities.

Who should consider using the CBOE NASDAQ-100 Buy Write V2 Index? According to CBOE, the buy-write strategy is suitable for an investor who is neutral to moderately bullish and willing to limit upside potential in exchange for some downside protection. For example, the Nasdaq-100 closed at 5789 at the end of May. If an investor thinks the Nasdaq-100 will advance further this year without a sharp correction of more than 5%, he should probably consider switching to BXNT which has paid a healthy dividend of about 7.8% over the last twelve months. The following payoff analysis shows how the Buy-Write structure can help investors protect against downside risk and harvest a sizeable 4.56% income payoff by the end of the year (Figure 5). Of course, under an extreme scenario that sees the Nasdaq-100 (NDX) rising another 500 points to 6289 at the end of the year, NDX will return an additional 8.64% but BXNT's payoff will be capped at 4.56%, thus underperforming its underlying index.

A Unique ETF Product with High Income, Low Volatility and Technology Focus

The Horizons Nasdaq-100 Covered Call ETF (Ticker: QYLD) is an investment product that is benchmarked to BXNT. QYLD has gained popularity because of the features of high yield and downside protection. It has paid monthly dividends in a range of 0.41% to 1.04% since inception.

There are very few products in the market that can pay the same level of dividend yield while bearing the same levels of risk. We have conducted a comparison study using Bloomberg's fund search function (FSRC). Our finding shows that the majority of the 463 US-based unleveraged fund products that have yielded greater than 7% over the last twelve months are high-fee open- ended fund products. Exchange-traded products only count for 3% of the 463 funds. More importantly, there are only eight technology-focused high yield products and QYLD is the only ETF in this category.

QYLD's trailing twelve month performance ranked 107 out of 463, easily inside the top 25% of its peer group. Its three year performance ranked 194, about the top 40% of its peer group. Its volatility ranked 24th, good for the lowest 5% of its peer group. Bloomberg also forecasted QYLD will yield more than 11% over the next twelve months. For the other six funds that Bloomberg forecasted to yield more than 10%, five are MLP or Energy-focused and the other is REITs-focused. QYLD stands out to be an ideal consideration for income investors’ add-on given the current record highs of the Nasdaq-100 and upcoming volatility concerns.

Conclusion

The Nasdaq-100 (NDX) has enjoyed a strong decade thanks to the right exposures that captured the growth of the new economy in the Technology, Healthcare, Consumer Services and other sectors. However, the Nasdaq-100 pays a 1.2% annual dividend yield and the index is a large cap growth strategy so its historical volatility is higher than that of its pure large cap peers. Given the recently achieved record high of NDX, income investors should consider using a Buy-Write (covered call) structure to shift some of the hopes of future gains to a steadier, monthly distribution with better downside protection. The CBOE NASDAQ-100 Buy-Write V2 Index (BXNT) and its corresponding Horizons Nasdaq-100 covered call ETF (QYLD) provide this unique combination of high income, low volatility and technology focus, and thus are an appropriate investment consideration for those seeking income with some potential equity upside.


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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.