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The rapid increase in interest in the stock market since the start of the pandemic has some important by-products. One of those is the rocketing appeal in using options as part of an overall investing strategy. Options are not new, nor are exchange-traded funds (ETFs), which have been around for more than 30 years. However, the combination of the ETF product structure, with options driving the performance from within, is entering a golden era of sorts.
What Are YieldMax ETFs?
Enter YieldMax ETFs, a recently-launched product line, launched through a collaboration between Tidal Investments (the advisor) and ZEGA Financial (the sub-advisor). The product line now includes more than 30 funds, just two years after the initial launch of a Tesla-based ETF (YieldMax TSLA Option Income Strategy (TSLY)) on November 22, 2022. At the core of these funds is the idea of taking the price volatility of an underlying stock or set of stocks, and using a strategy known as “credit call spreads” to convert that volatility into a high level of income, modest participation in price upside, and some degree of downside protection.
How YieldMax ETFs Work
YieldMax ETFs are typically a combination of three investments. First is a backing of the options strategy using U.S. Treasury Bills, which frequently make up more than 80% of the value of the ETF each month, when expiring options are replaced with newer options contracts. The other two investments are a pair of options. Instead of buying the stock outright, as some of its peers do, YieldMax buys call options to act as a surrogate for owning the stock. These are “out of the money” call options, which means that the fund can benefit from some of the future price appreciation, if any, in the target stock. The other option is the sale of a call option, which has a strike price between 0% and 15% of the current stock price. That means that the upside in the stock is limited, but in exchange for giving up that potential return, the shareholder receives a handsome income payout each month. Depending on the ETF and market conditions, Yield Max ETFs will also use other option strategies, such as selling put options. These obligate the holder of the option to buy the underlying stock at a future price that is typically below the price of the stock when the put option is sold. In other words, the investor is receiving cash now in exchange for the risk of being forced to buy the stock later.
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Key Components Of Yield
Max ETFs Underlying Assets
As noted above, the underlying assets are call options (bought and sold) and T-bills. The stock itself is not owned, and does not have to be for the strategy to work. The calls obligate the holder to produce the shares if “called” upon. And the sale of the other call position brings in the income.
Income Distribution
Income is generated from the sale of the call options, since the investor is sacrificing upside to be paid now. That income and any other cash flow resulting from the T-bills or other assets is delivered to shareholders in a monthly dividend.
Expense Ratio
Expense ratios for these ETFs are typically 0.99% of assets, which gets them just under the 1.00% rate that industry participants often screen for in considering candidates to be sufficiently cost-efficient. But frankly, YieldMax ETFs are a different breed altogether, given their tremendous income-producing potential. The product line also includes several applications of the strategy to more than a single stock, and those have expense ratios slightly above 1.00%.
Benefits Of YieldMax ETFs
This fairly new line of ETFs has attracted lots of attention during its first two years of existence. That is due to a combination of the popularity of the Magnificent 7 stocks like Nvidia, Microsoft, Tesla and Meta, and the increased demand for income from an ever-growing number of Baby Boomers, who are retiring or shifting from growth toward income in their investment objectives.
1. High Yield
These ETFs typically yield above their peers, since they aim to spin off option income from single stocks, which are more volatile than indexes (baskets of stocks).
2. Portfolio Diversification
There are some YieldMax funds that allocate among stocks, but the most popular so far have been the ones aimed at a single stock. While those stocks can present big risk from lack of diversification, the use of T-bills and options acts as a potential risk modifier.
3. Ease of Access
The ETF package is a nice match for the combination of call options known as a call spread. While the elements of these portfolios can be created and managed by investors on their own, there are variables each month based on how volatile the stocks involved and the market happen to be.
4. Monthly Or Quarterly Income
Monthly income from these ETFs is more in sync with the pace at which investors prefer to receive portfolio cash flow if they are using that money to live on.
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Potential Risks Involved with YieldMax ETFs
Market Volatility
Let’s be crystal clear on this. This is still stock market investing. So of course there is risk and volatility in the price of these securities.
Credit Risk
T-bills are considered to be very safe investments, and options are heavily-regulated and in the case of the contracts used by YieldMax, quite liquid. That said, if the fund company’s success reaches the point where they need to resort to private placement options contracts, as has been the case with other ETF producers, that could introduce credit risk.
Interest Rate Risk
Interest rates impact everything, as does market volatility. The key impact here is the extent to which rates hurt the prices of the underlying stocks, as well as the income available from that large T-bill allocation. Interest rates also may have an impact on the premiums available to bring in as income via the call option sales that drive these products.
YieldMax ETFs Vs. Traditional ETFs
YieldMax is not a new concept, but it does take the option-driven approach to another level. By applying call spread investing and trading to single stocks, investors who are income-oriented but would like to get a piece of the potential return from lower yield and no yield stocks, can look at YieldMax ETFs as a potential investment.
YieldMax ETFs Vs. Traditional Dividend Stocks
Dividend investing is changing rapidly. Stocks do not yield as much as they used to, thanks in part to rising stock prices and also because company management increasingly back stock instead of using their excess cash flow for dividends. And, short-term bond rates are much higher than a few years ago. That makes YieldMax ETFs an intriguing investment for those who want to complement their traditional approach to income investing.
Popular YieldMax ETFs In The Market
It should come as no surprise that the most popular YieldMax ETFs in terms of assets are those that target single stocks that are very popular. Those include NVDY (YieldMax NVDA Option Income Strategy), which applies the YieldMax call spread methodology to Nvidia; MSTY (YieldMax MSTR Option Income Strategy), which points to MicroStrategy, CONY (YieldMax COIN Option Income Strategy), which is based on Coinbase stock; and TSLY, in which Tesla is the underlying stock.
Fees And Other Considerations
The expense ratio and other fees, though modest for a product line as innovative as this one, is still a consideration for investors. When the yield is flowing and the stocks are holding up, that roughly 1% cost is lost in the profits and income. But in a sustained rough stock market, all costs of investing should get more scrutiny.
How Safe Are YieldMax ETFs?
Start with the idea that when investing, nothing is totally “safe.” But working up from there, the T-bills, options (which commit less money to the stock’s future price movement than buying shares outright) and the oversight of the firms involved here provide a competitive environment for these new ETFs to succeed.
Tips For Managing Risks Associated With YieldMax ETFs
The best thing investors can do in considering YieldMax ETFs is to understand the different parts of the fund’s asset allocation, how they work separately and together. Only then can someone determine to what extent, if any, the combination of features, benefits and risks fits for them.
Who Should Consider Investing In YieldMax ETFs?
Investors seeking to access the underlying stocks and stock baskets these ETFs aim to track, but do with higher expected income, are the most likely candidates to give YieldMax funds a good look. Personally, I own several of them, as a complement to my own dividend stock and income ETF portfolio. That said, I also take the additional step of using hedging mechanisms to buffer my portfolio against severe stock price weakness or other risks cited above.
Bottom Line
YieldMax ETFs are popular for many good reasons. But with any investment, it is a personal choice, and research and true understanding of what one is buying is the best way to meet your own expectations without risking disappointment.
Disclosure: I own several YieldMax funds.
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