I’ve warned you about avoiding the trap of “sucker yields” in the past…
Suppose ABC Inc. pays a $1 dividend and trades at $25 per share. That’s a 4% yield.
Now, assume investors worry that ABC Inc. can’t afford to keep paying that dividend. The stock might then fall to, say, $10 per share. So it looks like it’s now a 10% yield.
But good luck with that…
If the company cuts the dividend, any suckers who believed in the 10% yield will wind up with zero. And they’d likely be stuck with a bad company and no real reason to own shares.
That’s pretty easy to understand, right?
Well, in today’s essay, I’ll cover an intriguing twist to this idea…
As you’ll see, one investment yields nearly 13% today. And even better, it’s not technically a “sucker yield” because the monthly dividend probably won’t fall much – if at all.
But as I’ll explain, it’s still a trap that investors should avoid today…
The investment I’m talking about is the Global X Nasdaq 100 Covered Call Fund (QYLD).
In short, QYLD invests in the stocks in the Nasdaq 100 Index. That’s just like the more-recognizable Invesco QQQ Trust (QQQ). But there’s one important difference…
QYLD goes a step further. This exchange-traded fund (“ETF”) also generates income for shareholders by selling call options on the Nasdaq 100 Index.
Index options don’t involve the transfer of stocks. They’re “cash settled.”
The money value at the end of a trade is the difference between the index price on which you bet (the “strike price”) and the actual value of the index at expiration. And the folks running QYLD choose “at the money” strike prices with end-of-month expirations.
In other words, they bet on the Nasdaq 100 staying flat during the month.
On the third Friday of each month, QYLD’s managers sell a new at-the-money call for the next month. The money (“premiums”) that QYLD received from selling these options counts as income.
Most of these premiums are paid to shareholders as dividends. And they’re in addition to any regular dividend income the ETF receives from the companies in which it invests.
And the thing is… QYLD pays a pretty hefty 12.8% annual dividend yield today.
QYLD’s dividends vary based on market conditions. But they’ve been much more stable than typical sucker-yield stocks. Take a look at QYLD’s lifetime dividend track record…
As you can see, QYLD pays out a dividend between $0.10 and $0.25 every month. And it has done that consistently for the past decade.
If the Nasdaq 100 falls during a month, the option trade is successful…
QLYD keeps the premium and pays income to shareholders. And it profits from the cash settlement (a positive difference between the strike price and the actual index’s price).
It’s a classic “hedge” for investors in the Nasdaq 100…
In bear markets, it can work well. Option profits offset part of the Nasdaq 100’s declines.
But here’s where things become too good to be true…
You see, QYLD lags when the market is moving higher. Rising share prices are great. But option losses from betting against an index that’s moving up cut into investors’ returns.
The following table shows how QYLD’s total return (price change and dividends) compared with QQQ across various time periods over the past decade. Take a look…
In theory, a more stable, income-generating alternative to QQQ sounds great. But as you can see, it doesn’t really work in practice.
Sure, investing in Big Tech companies remains risky at the moment. However, with the market possibly near a major bottom, it doesn’t seem wise to bet against the Nasdaq 100.
In the end, I hope my point is clear…
QYLD isn’t technically a “sucker yield.” But it’s still a losing bet for investors.
Avoid falling into this trap.
Good investing,
Marc Gerstein
