Is the high dividend yield on the Global X Nasdaq 100 Covered Call ETF, QYLD, worth the loss in the stock price?
The Global X Nasdaq Covered Call ETF, ticker QYLD, is hugely popular with investors and for good reason. Not only does the fund pay a 12% dividend yield, one of the highest you’ll find in dividend stocks, but it puts cash in your pocket every single month!
A high dividend yield and monthly cash flow, what’s not to like about that?
But before you rush to your investing app to load up on shares of the QYLD, is it a good investment or is there something investors are missing? What are the risks in the QYLD and is the high dividend yield too good to be true?
What is the Global X Nasdaq 100 Covered Call ETF QYLD?
The Global X Nasdaq 100 Covered Call ETF is an exchange traded fund which means it holds stocks in an index and sells shares of the portfolio to investors. Those shares trade just like a stock so you get a great opportunity to own a basket of stocks with just one fund. For this, the QYLD charges an expense fee of 0.60% that is taken out of fund assets to pay for management.
What is the QYLD?
The fund tracks the Nasdaq 100 index which is the 100 largest companies in the Nasdaq. These are mostly tech companies but do have a few from other sectors like Pepsi and Costco because they are in the index. It holds shares in these companies in the same weights as the Nasdaq, according to their market size, which means it has much more of Apple (13.0% of the fund) versus OKTA Inc (0.12% of the fund).
If you ever want to see exactly what stocks are in an ETF, including the QYLD, you can go to the fund page and look for ‘Holdings’ in the menu. I’ll show you exactly how the QYLD works later but now let’s look at the dividend yield and QYLD dividend history.
QYLD Dividend Yield and Dividend History
The current dividend yield is 12% or about $0.179 per share paid out every month but that might be misleading to new investors. The payment amount is often cut along with the stock price so you might not be collecting 12% for as long as you hold the fund.
Let me explain after this table of the QYLD dividend history.
QYLD Dividend History
The Global X Nasdaq Covered Call ETF does pay monthly dividends, which is great, but like Forest Gump’s box of chocolates…you never know what you’re going to get. The dividend has been cut regularly from as high as $0.22 a share last year to now just $0.179 in the most recent dividend payment.
Why did this happen? Why did the QYLD cut its dividend? We’ll see how the QYLD works next but the fund is selling covered call options to generate income to pay for the dividend. The problem is, as the stock value of the holdings falls then the fund collects less for those call options and so less income is generated to distribute to investors.
That’s why dividends will continue to follow the ETF price and why the current dividend yield is a little misleading. Investors that bought QYLD at $22.40 just a year ago are now earning a yield of just 9.5% and could see it fall further.
How Does the QYLD Work?
The QYLD uses a covered call strategy on the Nasdaq 100 index, that’s the 100 largest companies in the tech-heavy Nasdaq. So what it’s doing here is it’s buying the 100 stocks in this index, mostly large technology companies, and then it’s selling call options against them.
Call options give an investor the right to buy a stock at a certain price up to a set date and for that right, they pay the other investor a premium up-front. For example, if I owned shares of Tesla but were worried it might come down from the current $800 share price…or if I just wanted to create a cash flow from this non-dividend paying stock, I could sell a call option to another investor.
How the QYLD Works
Looking at the last line of the fund’s holdings, you see how this works. The fund has sold calls against the Nasdaq index expiring mid-month for a market value of $326 million, which is about 1.8% of total fund assets.
There are a few things that are important there to help you understand the strategy and where the risks are, and why the fund might underperform others.
First, the fund is selling calls against about 2% of its stocks each month, just enough to produce the cash needed to pay out that 12% annualized dividend yield. The cost of selling those calls every month is going to be a drag on the performance, though it’s fairly small. Also though, just using that covered call strategy, means if the stocks in the Nasdaq jump higher in one month…the fund is going to miss out on some of that because it’s sold another investor the right to buy those shares for cheaper. That’s why you saw the QYLD underperform the Nasdaq tech stocks by so much over the last five years.
Another weakness though is that because the QYLD is a fund of over 100 stocks, it loses the opportunity to run higher if any of those stocks does really well. The non-tech stocks like Constellation Energy and Ross Discount Stores tends to slow the growth and the returns versus growth stocks.
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What is the Risk in QYLD?
Investors get dollar-signs in their eyes when the see a 12% dividend yield but don’t realize the risks in the QYLD until too late. The ETF is down 20.5% over the last year versus a 15.2% loss on the Nasdaq 100 index. The QYLD is down 24.6% over the last five years, underperforming the 84.5% gain in the Nasdaq. Investors got that constant dividend but missed out on 100% in returns.
Is the QYLD a Good Investment
We’ve already touched on some of the QYLD risks. The lower share price means the dividend falls and investors holding the stock may not get the dividend yield they expected.
Because of that covered call strategy, the QYLD will almost always underperform the stocks in the Nasdaq 100 when the market rises. The fund sells another investor the right to buy those shares at a fixed price so misses out on some of the upside.
The fund should protect investors a little when stocks prices fall. On a dividend-adjusted basis, the loss on the QYLD is slightly less than the price loss on the Nasdaq 100.
Is the QYLD a Good Investment?
I wouldn’t say the QYLD is a bad investment but it’s not as good an investment as many investors think either. The Global X Nasdaq Covered Call does offer that high dividend yield and pays on a monthly basis which is more important for some investors but there is a tradeoff.
You’re asking yourself, but if the plan is to hold the QYLD forever and just keep collecting that dividend…what does it matter if the share price falls? I’m not selling so I’ll never care.
And you know I love the buy-and-hold strategy but you’ve also got to ask yourself…how many stocks do you own right now that you’ve held for more than maybe a year or two? In fact, data from the New York Stock Exchange shows the average holding period for a stock is now just 5.5 months.
Even if you truly intend to hold the QYLD forever and resist the urge to sell, a lot of life happens in thirty or forty years. Expenses come up and even that 12% annual dividend isn’t going to be enough for most people to live on in retirement. Even on a $100,000 portfolio, that 12% dividend yield is only a thousand dollars a month. You’re going to need to sell the shares and when you do, it’s going to suck if you have to sell them for less than you paid.
So unless you are confident you can hold the QYLD forever and never sell, then you’re going to be booking a much lower return than expected because loss on the stock price will eat into what you collected in dividends.
For that reason and the other risks in the QYLD, I would suggest other ETFs and stocks for your portfolio.
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Monthly Dividend Stocks Like the QYLD
There are several ETFs that work just like the QYLD and pay monthly dividends. Of course, before you rush out to buy these instead, they suffer from many of the same drawbacks as the QYLD. Some though don’t see their share price fall as fast and can be better QYLD alternatives.
The Global X Russell 2000 Covered Call, ticker RYLD, is very similar to that QYLD strategy. Here instead of holding tech stocks, the RYLD is holding shares of companies in the Russell 2000 index which are the smallest two-thirds in the stock market. So the focus here is going to be on that growth you get from small-cap stocks but with the income generation through those covered calls.
Stocks Like the QYLD
The dividend yield is the same as the QYLD at 12% and the fund has produced a 14.4% annualized return since May 2019. The RYLD uses that same covered call option strategy but it does it in a very simplified way. Here, instead of holding the individual stocks in the index like the QYLD did, this fund just invests directly in a fund that holds those stocks. The fund is holding only the Vanguard Russell 2000 Fund and then selling the call options against it and just like the QYLD, it sells those one-month call options worth about 1% of the assets.
So again, notice that these funds aren’t hedging their entire portfolio every month. They might have fund assets of say $100 million but then are only selling calls against that worth one million, so generating a 1% monthly income on the entire fund.
Pros of the RYLD ETF are that you get growth stock exposure to those small cap stocks, so a different group compared to the big company stocks you’ll see in these other funds. You also get a high dividend yield.
The drawback to the RYLD is that because it invests in the Vanguard fund instead of the individual stocks, you’ve really got kind of a double cost here. The fund is paying an expense ratio of 0.1% to Vanguard and then you’ve got all the Global X costs on top, so this one is a little more expensive at a 0.6% expense ratio for investors.
The JP Morgan Income ETF, ticker JEPI, is another popular one though the dividend yield of 7% is a little lower.
Just like the other two funds, this one is selling covered calls for income but here it’s against shares of the large-cap stocks in the S&P 500 index. It pays a 7% yield, paid out on a monthly basis, and best of all the expense ratio is the lowest of the group at just 0.35% and the return of 22.9% has been the highest.
The fund’s strategy is similar to the RYLD because a big part of its holdings are in notes that track the entire S&P 500 directly but if we scroll down, we see it also has positions in the individual stocks themselves. These are all those largest companies in the S&P index and holding individual shares gives the portfolio managers the opportunity to focus on some of those stocks more than what they might be in the index.
And thing to understand about all these funds is the importance of a good portfolio manager. Unlike most ETFs where the fund invests passively in stocks given an index to follow or a set of rules for which stocks it buys, these funds are actively managed. That means the portfolio manager is given more responsibility for picking stocks and in this case they options used as well. So the portfolio managers in these funds, not only are they picking the stocks they think will produce higher returns but they also have to pick the options strike price that will maximize income but not give up too much return.
I think this is where the JEPI ETF has done really well with current managers Reiner and Zingone counting more than 60-years in the industry between the two and 40-plus years at JP Morgan.
Pros of the JEPI ETF are that it’s a well-managed fund, evidenced in that higher total return versus the others in our list. It also gives you exposure to a broader set of stocks across the S&P 500 rather than focused on a group like tech or small-cap.
The downside here is probably that lower dividend yield. The managers here have definitely given up some cash return in favor of the higher total return upside.
Dividend Stocks Better than the QYLD
There are also several monthly dividend stocks that can provide that constant cash flow but without some of the risks of the QYLD. Of course, they come with risks of their own and aren’t as diversified as an exchange traded fund. I’ll reveal the stocks I like better than the QYLD in this video.
Horizon Technology Finance, ticker HRZN, is a unique case in BDCs along with its 7.7% dividend and 17.5% annual return.
Horizon makes secured loans to venture and private-equity backed companies in the life sciences and technology industries…so you get that strong cash flow on the loans but also longer-term growth from the equity investment.
The portfolio of loans is well diversified by sector, geography and company stage. All these are going to be those fast-growing startups backed by venture capital and again, a great niche in healthcare and technology.
So besides that high yield you get from the typical business development corporation, here you get a little bit of growth stock as well.
The average yield on portfolio debt is 16.3%, well above the 7% dividend yield, in fact I think the biggest yield spread I’ve seen in a BDC stock. That keeps the dividend safe and will mean the stock price should continue to rise.
Next on our monthly dividends list is a fan favorite, Gladstone Investment Corporation, ticker GAIN, for a 6% yield and 19.7% annual return over the last five years.
Stocks Better than QYLD
And why I like GAIN here is because it takes a higher equity share than most other BDCs. Remember, those business development corporations are mostly making loans so the upside is capped at the interest rate. But Gladstone’s target investment is 25% equity and 75% debt versus a traditional BDC that will look for less than 10% equity in the companies it works with. That higher equity ownership might mean higher risk but it’s also going to mean higher returns on these investments.
And we see that in GAIN’s history of return on equity which is well above the industry average. The five-year average ROE of 17% is over three-times the median ROE for the BDC group and even though near-term return has come down, it’s still well above the average for the group.
Gladstone’s current portfolio is spread across 28 companies in 14 industries so a level of diversification there that should help it continue those returns even in a sluggish economy. The shares have done so well in fact that it’s been able to pay out multiple special dividends, boosting that cash return.
Is the QYLD a good investment? That depends on what you need as an investor. For those that only need cash flow each month, the QYLD does pay one of the highest dividend yields for monthly dividend ETFs. For most investors though, I would say there are better alternatives to the QYLD that don’t suffer from all the risks or downside.
Read the Rest of the Monthly Dividend Stocks Series!