Over the past two years, Wall Street has convinced cautious equity investors to send billions of dollars into exchange-traded funds that use options to goose yields.
A vocal chorus of analysts has been warning against this booming trade, to no avail. Assets in derivatives-powered ETFs have quadrupled to $69 billion.
Now
"The value really isn't there," said
Sold by firms including JPMorgan Chase and Global X ETFs, the strategies — which own stocks and trade options on the side to raise extra money — have a been a minor craze since the 2022 bear market, when they massively outperformed equity indexes. Over half of the 75 covered call products tracked by Bloomberg have been started in the past 16 months.
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Two of the most popular products, the JPMorgan Equity Premium Income ETF (ticker JEPI) and the Global X Nasdaq 100 Covered Call ETF (QYLD), illustrate the issue. In 2022 when stocks plunged, JEPI and QYLD beat the S&P 500 and Nasdaq 100 by about 15 and 13 percentage points respectively. But as the overall stock rally gained momentum in the past year, the S&P 500 has beaten JEPI by 14 percentage points, and the Nasdaq 100 has outperformed QYLD by 19 points.
To proponents, data like that are only half the story. People buying the ETFs are attracted to their payouts and are willing to forgo upside in exchange for a position they perceive as less risky.
"For many covered-call investors, the goal is less about tactical outperformance and more about achieving a stated objective. In many cases, the key consideration is income," said Rohan Reddy, the director of research at Global X. "The sacrifice for generating higher income often comes in the form of giving up total returns."
JPMorgan didn't respond to a request for comment.
To demonstrate the potential drag, the
The issue is both the rising market and chronically low premiums collected on bullish options due to the momentum of equity indexes over the past year, Woodard said.
"You're getting hurt in two ways. You're missing out on upside in the market, and you're not being compensated the way that you historically would've done for selling those options."
With the call overwriting being unprofitable in the past two years, simpler exposures to dividend stocks has provided superior returns. The First Trust Morningstar Dividend Leaders Index Fund outperformed a basket of option-income ETFs by 8% since 2018, the strategists found.
Complex options products also provide fewer tax advantages than high-dividend ETFs, according to
High-dividend funds could offer similar yields to option income ETFs on a tax-adjusted basis, the bank finds. Global X's Reddy notes that some covered calls ETFs have some tax advantages since a big part of their distributions could be classified as return of capital.
Investors who flocked to such products amid a five-month rally that boosted stocks by $10 trillion have underperformed underlying indexes. Their best hope now is for a more gradual rally or a slow selloff.
"Call overwriting will underperform when stocks are trading higher," said Chris Murphy, the co-head of derivatives strategy at Susquehanna International Group. "It does appear the extreme rally from October to March has shown signs of closing so it could be a decent time for overwriting to make a comeback."
Meanwhile, some financial advisers are steering clients to hide out in bonds, which offer yields above 5% and that investors don't lose their principal.
"People are just saying, 'Ok instead of 5.5% , I can get 7%'—but when things go down, that's going to go down worse," said Sam Huszczo, founder of SGH Wealth Management. "You're still taking on way more risk than a traditional corporate bond getting 5.5%."
