What are YieldMax ETFs?
YieldMax ETFs are a series of exchange-traded funds designed to generate high income for investors with unique investment strategies, mainly covered call options strategies. YieldMax has launched 30 ETFs, including 19 single stock ETFs with yields ranging from 15% to as high as 165%.
These funds focus on generating high yields, often significantly higher than traditional incomel-focused ETFs, and they invest in a wide range of sectors and asset classes.
Their newest fund, YieldMax Universe of Options Income ETF, aims to provide a well-balanced portfolio by investing in all YieldMax ETFs and rebalancing monthly to ensure equal weighting.
In addition to possibly high income, these ETFs offer potential for capital growth as the value of the underlying stocks my increase over time.
Popular YieldMax ETFs
As we can find on the YieldMax ETFs website, here are some examples of popular YieldMax ETFs, highlighting their focus and strategies. You can also check their prospectus to find out more (for example, TSLY prospectus).
It is shown that YieldMax ETFs have four major categories: Covered Call ETFs, Ultra ETFs, Fund of Funds ETFs, and Short Option ETFs. Their categorisation demonstrate minor difference in their strategy but much in common.
In the following part we will talk mainly about the most popular products in the YieldMax series and how they work.
YieldMax Universe Fund of Option Income ETFs (YMAX)
It is a high-risk “fund of funds” that reallocates monthly to equally weight its holdings in various YieldMax ETFs, capping gains but exposing investors to full potential losses of the underlying securities. The fund is actively managed and focuses on generating current income. It invests in ETFs rather than individual company shares and is expected to pay monthly distributions, though these are variable and not guaranteed.
Since January, YMAX has returned 14.28%, slightly trailing the S&P 500’s 17.37%. The fund sells out-of-the-money calls and reinvests proceeds into income-producing assets like government bonds.
YieldMax TSLA Option Income Strategy ETF (TSLY):
It utilize covered call options on Tesla stock (TSLA) to generate high yield while maintaining exposure to Tesla’s growth potential. As shown in the screen shot, it has a distribution rate of 83.57%.
(For specific analysis of TSLY, please refer to another article on our website.)
YieldMax NVDA Option Income Strategy ETF (NVDY)
It employs options strategies on Nvidia stock, aiming to provide substantial income with exposure to the semiconductor industry.
YieldMax AAPL Option Income Strategy ETF (APLY)
It focuses on generating income through options on Apple stock (AAPL), benefiting from the tech giant’s stability and growth.
YieldMax MSFT Option Income Strategy ETF (MSFY)
It invests in options strategies related to Microsoft (MSFT), providing income and exposure to the software and tech industry.
YieldMax META Option Income Strategy ETF (META)
This ETF utilizes options ot generate income while investing in the social media and digital advertising space.
YieldMax QQQ Option Income Strategy ETF (QYLD)
This ETF sells covered calls on the NASDAQ-100 Index, providing diversified exposure to leading tech companies with high yield.
It is noted taht YieldMax ETFs often invest across various sectors, including technology, healthcare, consumer goods, and more, offering broad exposure and reducing single-stock risk.
Meanwhile, some YieldMax ETFs are “funds of funds” (FOFs) investing in multiple other YieldMax ETFs, for example, the YieldMax Universe Fund of Option Income ETFs (or YMAX).
How YieldMax ETFs work?
One of the biggest reasons why investors choose YieldMax ETFs is that they are known for offering attractive dividend yields, often ranging from 20% to over 40%, which is achieved through options strategies beyond traditional dividends.
The major options strategy involves selling call options on the underlying stocks held by the ETF. This approach generates premium income.
Most YieldMax ETFs use synthetic options strategies to replicate the performance of underlying stocks.
Covered call options
Let’s use YMAX as the target ETF that holds a portfolio of stocks, among which are 1,000 shares of a stock called ABC Corp, which is currently trading at $100 per share.
The ETF sells call options on these shares with a strike price of 105 within expiration date one month away.
The premium of each call option sold is $2.
The ETF writes (sells) 10 call option contracts (since each contract typically covers 100 shares) for its 1,000 shares of ABC Corp. The total premium income generated from selling these options is $2,000.
Calculation: 1,000 * $2 = $2,000
There are two possible scenarios at expiration:
Scenario 1: stock price remains below $105
The option expire worthless and the ETF retains the $2,000 premium income without selling any shares.
Scenario 2: stock price exceeds $105
The call options are likely to be exercised and the ETF sells the shares at $105 per share, making a capital gain of $5 per share. The total income equals $7,000.
Calculation: $5 * 1000 + $2,000 = $7,000.
Benefits of covered call options
While it limits upside potential beyond the strike price, it effectively generate income and provides a buffer against moderate declines.
As you can see from the chart, the blue line shows the payoff from the covered call strategy across different stock price at expiration.
If the stock price drops below the initial price ($100), the investor incurs a loss but the this loss is mitigated by the $2 premium received, providing a slight cushion.
If the stock price ranges between $100 and $105, the investors benefit from both the premium income and any capital gains up to the strike price ($105). The maximum gain is capped at $7 per share ($5 capital gain + $2 premium)
If the stock price exceeds the strike price, the payoff becomes constant because the investors have to sell the stock at $105 and cannot participated in any further upside gain beyond this point.
After the expiration date
Of course, when the strike price is hit, the ETF can reinvest the gains received from selling shares into other opportunities, which might align with its broader strategy and investment goals. These oppportunites could include rebuying ABC Corp shares, buying other shares, or holding cash.
If ABC Corp paid dividends, losing the shares would also result in losing future dividend income from those shares.
Choosing covered call options can generate stable monthly income from option premiums, providing an additional source of income.
This strategy is well-suited for investors who are willing to sell their shares at a specific strike price and are seeking income through selling call options when the prices of stocks or ETFs have limited upside potential. Additionally, this strategy is advantageous because it can bring stable income in fluctuating markets, as long as prices remain stable or rise slightly.
Stocks for covered call options
Covered call options are a popular strategy among investors to generate additional income from their stock holdings while managing risk. However, certain type so f stocks are more suitable for this strategy. Most of them would have the following features: stable stock price, low volatility, stable divdidends, and leading positions in specific industries.
Stable or slow-growing
Stocks that are stable or have slow growth are ideal because the potential upside is limited, aligning well with the capped gains of a covered call strategy. Investors can benefit from premium income without woring about missing out on significant capital apppreiciation.
The typical examples are consumer staples stocks like Procter & Gamble (PG) and Coca-Cola (KO), which exhibit slow and steady growth and low volaitliy. Similarly, utilities stocks like Duke Energy (DUK) or Southern Company (SO) often have steady and predictable revenue steams and moderate growth.
Dividend-paying
Dividend-paying stocks offer a dual income stream from both dividends and option premiums, providing a consistent income for investors. Companies in sectors like telecommunications and real estate investment trusts (REITs) are known for their high dividend yields, such as Verizon (VZ), AT&T (T) and Realty Income (O), etc.
Stocks with low volatility
Stocks with low volatility are less likely to experience drastic price movements, reducing the risk of options being exercised unexpectedly. Companies like Johnson & Johnson (JNJ), Pfizer (PFE), McDonald’s (MCD) and Walmart (WMT) often have stable stock performance due to consistent demand.
Large-cap companies
Most of the companies are also large-cap companies, with less speculative price movements, making them suitable for conservative covered call strategies. While tech stocks can be volatile, giants like Apple (AAPL) and Microsoft (MSFT) may offer stable growth. Besides, Bank of America (BAC) and JP Morgan Chase (JPM) are also good fits for the covered call strategies.
Why Nvidia and Tesla are also included
It may seem counterintuitive that some YieldMax portfolio would also include high-growth stocks like Tesla and Nvidia with higher volatility, given the strategy’s traditionally conservative nature.
Higher volatility of these stocks also offer higher option premium. For example, the KO option premium could be $0.5 while that of TSLA could be $20 (this is for basic comparison purpose only, you can check the real bid-ask prices).
Therefore, including these stocks in some portfolio could be a strategic choice for enhancing yield through higher option premiums. Despite the capped upside, these stocks provide an attractive combination of income generation and risk management.
Who are paying for the strategy?
The options strategies look like a zero-sum game, but it is not correct, to some degree.
Based on some studies done by different organisations, the covered call options strategy for S&P 500 outperformed the S&P 500 itself for many years before 2015.
Before it is proved not correct in the years after 2015, many people would ask, if conducting covered all options can bring stable additional income, who are paying for the income and why?
First, there are bullish investors who believe that the price of the underlying stocks will rise above the strike price before a certain date. Then they might purchas call options with strike prices. In contrast to option sellers, they pay the premium to acquire the right, but not the obligation, to purchase the stock at a fixed price (the strike price). This provides them with limited downside risk (limited to the premium they pay) and unlimited upside potential.
Second, some speculators aim to earn short-term profits from volatile markets, especially they anticipate a rapid increase in stock prices for some reasons.
Third, there are hedgers who typically aim to protect existing holdings. They purchase call options to hedge against uncertainty when the prices drop, and are concerned about missing out on potential future gains if the stock price rises significantly. To manage this risk, they decide to purchase call options as a form of insurance as the price of call options are acceptable.
But is it a win-win game? While it is not a traditional win-win in every scenario, it overall provides benefits that align each participant’s objectives: the seller gains income stability while the buyer leverages potential upside with limited risk.
To some degree, they are providing hedging or insurance to each other and sharing the benefits and risks.
Synthetic call writing strategy
YieldMax ETFs often employ sophisticated synthetic options strategies to optimize returns and manage risk. These strategies enable the funds to achieve specific investment objectives without directly holding the underlying assets.
It consists of a long position in the underlying stock and short position in a call option. For example, many YieldMax ETFs use synthetic covered calls to enhance yield and offer downside protection with premium income.
For example, YMAX uses “Call Writing Strategy” (mostly covered call strategy, though call writing strategy could also include naked call strategy without owning any underlying stocks).
Some other ETFs like TSLY, are using Synthetic Call Writing Strategy.
This synthetic call writing strategy of the TSLY has two parts: Synthetic Positions and Call Writing.
Synthetic Positions (Synthetic Long Stock Position here): The fund does not hold Tesla shares directly, which suggests that it uses financial instruments to simulate holding Tesla stock. It buys call options and sell put options to simulate the effect of holding Tesla stock without actually owning it.
Call Writing: The fund generates income by selling call options on Tesla. We have explained about this in the covered call strategy mentioned before.
Synthetic Long Position
Let’s assume that for ABC stock, we have the following parameters for call options and put option.
Strike Price: $150
Call Premium: $5
Put Premium: $5
Payoff from Call = max(Stock Price−Strike Price,0)
Payoff from Put =−max(Strike Price−Stock Price,0)
Net Premium=Call Premium−Put Premium
(Net premium could be 0 here.)
Net Payoff=(Payoff from Call−Payoff from Put)−Net Premium
As you can see from the chart below, it mimic the result of holding a stock without owning it (the blue line is the payoff of the synthetic long position, which is similar to the real stock payoff).
How we calculate the yield of YieldMax ETFs?
Let’s look at the YMAX as an example, which is very diversified as mentioned. It has Distribution Rate of 43.93% and 30-Day SEC Yield of 65.24% (as of August 5th 2024), and it is reminded that these rates would change over time after its inception early this year.
On one hand, its price has dropped to $17.05 (August 5th 2024, within 52-week range of 15.69 to 21.94) as the most of the stocks it is holding are also plummeting.
It has performance of more than 13.85% as of the end of July by the YieldMax website with a gross expense ratio of 1.28, while its performance indicated by Yahoo as of August 5th is 12.64%.
Distribution details
As it says on the website that it has a distribution rate of around 44%.
When we compile the distribution data with distributions per share and payable dates from the website and convert it into Google Sheets (or Excel Sheets), we got the following table. It has an average distribution per share at $0.64 and a total distribution of $3.85 YTD.
If we are using the average monthly payment of distribution at $0.6412, the annual yield is 45.13%.
Here is how we calculate it:
Annual yield = Average monthly payment * 12 / Current Price = 0.6412 * 12 / 17.05 = 45.13%
(Some websites show that its dividend yield is around 22%, which is calculated from all six dividends from February to July, rather than 12 dividends of the whole year 2024)
https://stockanalysis.com/etf/ymax/dividend
If we use a simple dividen calculator (we use this one from trackyourdividends.com), we can have the following results assuming that we invest 50,000 as starting principal in 20 years with annual dividend yield of 45%.
Then we will become millionaires in 10 years with a portfolio value of $1.17 million. At the end of the 20th year, we have $9.5 million! This is the power of reinvesting and compounding.
However, this scenario is kind of oversimplified without considering tax rate and practical changes when the ETF grows larger in the future. For example, as you can see, the monthly payment decreased from $0.73 in May to around $0.65 in July. It is still hard to tell whether it would decrease further or not.
On the opposite way, we don’t consider the annual share price growth or dividend growth rate yet in this simple model, and we calculate the inflation as the yield rate is decreasing. It dipped to 23.9% in the 10th year.
However, this is humanly impossible. The calculation would change highly if we include considerations of underlying stocks’ price changes, taxation, NAV erosion, and inflation etc.
Benefits of YieldMax ETFs
Choosing covered call options can generate stable option income each month, which can be regarded as additional income.
This strategy is a good fit for investors who are willing to sell their shares at a specific strike price, and is seeking income through selling call options when the the prices of stocks or ETFs face difficulty to increase.
It is also advantageous that this strategy can bring stable income when the price fluctuates, only if it is stable or rise slightly.
Are YieldMax ETFs safe?
They are suitable for investors seeking alternative income but carry inherent risks of covered call strategies.
The first one is to get alerted for the hidden risks behind mind-blowing high yields of these YieldMax ETFs. (We mentioned this in another article specifically for TSLY, but the same risk applies to most of the ETFs in the family.)
For Covered Call Options strategy
Risk: Performance in different markets
According to a study by CBOE, the BXM Index (CBOE S&P 500 BuyWrite Index), which tracks the performance of a covered call strategy on S&P 500, consistently outperformed the S&P 500 from 1988 to 2015, in terms of risk-adjusted returns, especially in flat or declining markets. What’s more, the BXM had lower volatility. Some other reports years ago also proved these findings.
However, the comparison has been totally inaccurate after 2015.
A simple comparison of the performance of SPY (S&P 500 ETF) and XYLD (Global X S&P 500 Covered Call ETF), which generally correspond to the performance of the CBOE S&P 500 BuyWrite Index (BXM Index), before fees and expenses.
As we can see from the SPY outperformed XYLD in the last 10 years since 2015, based on a comparison chart from Portfolioslab.com.
According to another study by First Trust Portfolios, the BXM only outperformed the S&P 500 Index in just four of the 19 calendar years.
It also shows that he use of a covered call portfolio tends to be most beneficial to investors when the stock market posts down years (2008) and when returns range from 0% to 10% (2007, 2011 and 2015).
In contrast, covered call writing tends to be less beneficial when stock market returns are above 10%.
Overall, covered call ETFs tend to perform better in flat or declining markets where high premiums can offset losses or stabilize income. Though, this strategy may underperform in rising markets due to capped upside as gains above the strike price are not realized.
According to a report released by CAIA Assocition website, while covered call strategy can be effective for generating income, especially in stable and slightly bullish markets, it carries hidden costs that can impact overal portfolio returns.
Risk: Opportunity cost
Another big risk is the opportunity cost to harvest upside gains in high growing stock. It is a trade-off if investors want to have some cushion effect when they faced slight declines.
While YieldMax ETFs offer attractive benefits for those who are seeking significant income potential and the possibility of capital growth, there are also risks and considerations.
YieldMax ETFs focused on individual stocks (e.g., TSLA, AAPL, etc.) are subject to the performanc and the risks associated with those specific companies.
As some of these stocks would have higher volatility, the biggest risk is the opportunity cost of huge upside gains in these stocks.
A Youtuber compared the performance of the YieldMax ETFs and their underlying stocks and found that they have generally underperformed their underlying stocks. These ETFs may be suitable for those needing immediate income, but long-term investors are advised to avoid them or invest only a small portion of their portfolio in these products.
Risk: Short history of YieldMax ETFs
For most of the YieldMax ETFs, they have relatively short history and they need to be tested in a longer term for their performance and risks.
For example, YMAX is less than a year old, so there’s not enough history to consider retiring on it. Let’s wait to see how it performs over the next five years before investing heavily.
Investors with higher risk tolerance might find YieldMax ETFs appealing for short-term gains, but these funds are not proven for long-term investing. It’s essential to consider the fund’s performance over time and the associated fees before committing. Diversified, lower-risk ETFs like QYLD and JEPI, offering around 12% yield, may be preferable for those prioritizing capital preservation.
Risk: Fund management and expense ratio
It is also noteworthy that these ETFs are actively managed, allowing fund managers to adapt strategies based on market conditions and optimize returns.
Besides, the YieldMax ETFS have relatively high gross expense ratio, for example, YMAX with 1.28% ratio (as of August 2, 2024), compared to more established ETFs like the S&P 500, which charge less than 10 basis points. This could bring huge impact in long-term compounding even if it has a high annual yield.
Risk: Tax implications
It is noted that the income generated from selling call options is typically treated as short-term capital gains, which may be taxed at higher rates compared to qualified dividends or long-term capital gains.
Risk: Decreasing dividends and dividend tourists
We find from the volume chart that The overall upward trend in volume from February to August indicates growing investor interest and increased liquidity of YMAX.
It also shows a significant increase in trading activity in late June and July, indicating heightened interest possibly related to ex-dividend dates.
Besides, the consistent spikes in volume suggest a pattern of buying and selling around specific market events, possibly by “dividend tourists”, who buy them before ex-dividend dates to capture the dividend payout and then sell the shares shortly after.
As we can see from the chart, in June, the number of YMAX shares increased from 9,500,000 to 12,500,000 in the last three days before the ex-dividend date. This increase in shares diluted the dividend, causing it to drop from $0.85 to $0.73.
However, as the fund grows and matures, the impact of ththse last-minute buyers on the yield could diminish and would have a more stable dividend fund in a normal market.
https://stockanalysis.com/etf/ymax/dividend
For Synthetic Options Strategy
While a synthetic long position offers certain advantages, it also comes with significant risks.
Margin risk
One of the risks specific for this strategy is the margin risk, which requires investors to maintain sufficient margin in their account to cover short put position. A sudden market move against your position would trigger margin calls.
For example, if you sell a put option as part of your synthetic long position, it would require a margin of $1,000 in your brokerage account. If you fail to meet margin calls, it can lead to forced liquidation of your positions at unfavourable losses.
Transaction cost
Another risk is the transaction costs, which includes commissions, fees, and bid-ask spreads associated with trading options. These costs can accumulate and erode potential profits, particularly in active trading where you frequently adjust your synthetic long position in a volatile market to manage risk.
Early assignment
In US options markets, selling put options exposes you to the risk of early assignment, especially if the options are in-the-money. This can disrupt the synthetic position and result in unexpected obligations.
Assume ABC stock is currently trading at $800, and you have sold put options with a strike price of $790, expiring in three months. Two months before expiration, ABC stock price drops to 780, causing your $790 strike put option to be in the money.
Due to this in-the-money status of the put options, the option holder decides to exercise the puts early. You can then assigned, which means you are obligated to buy the shares of ABC per put option contract at the trike price of $790.
This results in an immediate unrealized loss of $10 per share. What’s more, you cannot hold the share and cannot wait until the price would rise. You may also need to rebalance your position by selling the shares and re-build your synthetic long position.
Interest risk
Last, as there would be a period before expiration, interest rate changes can affects the pricing of options, particularly the longer-dated options. If interest rates rise unexpectedly, the present value of future option payoffs may decline, affecting the strategy’s profitability.
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