Comparing Covered Call ETFs: QYLD, JEPI, and JEPQ

Introduction to Covered Call ETFs

Covered call ETFs have gained popularity among income-seeking investors in recent years. These funds aim to generate high yields by selling call options on the stocks they hold. Three prominent covered call ETFs based on the Nasdaq-100 index are QYLD, JEPI, and JEPQ. This article will compare these funds across five key metrics:

1. Income level
2. Income consistency
3. Long-term growth potential
4. Downside protection
5. Tax efficiency

Before diving into the comparison, let's briefly review how covered call ETFs work.

How Covered Call ETFs Operate

Covered call ETFs employ a two-step strategy:

1. They purchase stocks, typically tracking a major index like the Nasdaq-100.
2. They sell (or "write") call options on those stocks.

A call option gives the buyer the right to purchase a stock at a predetermined price (the strike price) by a certain date. By selling call options, the ETF generates income from the option premiums. However, this strategy caps the potential upside if stocks rise significantly above the strike price.

The trade-off is clear - covered call ETFs offer higher yields in exchange for limited upside potential. Now let's examine how QYLD, JEPI, and JEPQ compare across our key metrics.

Income Level Comparison

One of the primary reasons investors are drawn to covered call ETFs is their high yields. Let's look at how QYLD, JEPI, and JEPQ stack up in terms of income generation.

QYLD

QYLD shows the highest yield at 14.1% based on its distribution rate. This fund writes options on up to 100% of its portfolio, slightly out-of-the-money, to generate consistent monthly income. Based on analysis of its holdings and options contracts, QYLD likely writes options on 75-90% of its portfolio that are 1-4% out-of-the-money.

JEPI

JEPI quotes a dividend yield of 12.3%. However, this fund uses a different approach, selling options through equity-linked notes (ELNs) on up to 20% of the portfolio. The true options exposure is likely higher due to leverage within the ELNs. Based on its distribution history, JEPI's options likely cover most, but not all, of its portfolio.

JEPQ

JEPQ quotes only a 0.5% SEC yield, which excludes income from options premiums. Using the same calculation method as the other funds, JEPQ's yield would be around 10.7%. This fund sells at-the-money or near-the-money options on 25-75% of its portfolio.

Yield Comparison Analysis

When comparing yields, it's important to look beyond the headline numbers. The 12-month distribution yield provides a more accurate picture than shorter-term measures. Using this metric:

• QYLD: Estimated 14.4% (based on 9 months of data)
• JEPI: 9.6%
• JEPQ: 9.9%

QYLD is likely to maintain the highest yield among these funds due to its aggressive options writing strategy. JEPI's yield may decline over time as interest rates and volatility normalize. JEPQ aims for yield consistency, so its income is unlikely to surpass QYLD's.

Income Consistency

For many investors, especially retirees, consistency of income is just as important as the overall yield. Let's examine how these ETFs perform in terms of maintaining steady distributions.

QYLD

QYLD is specifically managed to keep income consistent. Since its inception, QYLD has maintained relatively stable monthly distributions. This consistency is a key selling point for investors seeking predictable income streams.

JEPI

JEPI also aims for income consistency. Its monthly distributions have remained fairly stable since the beginning of 2023, with only minor fluctuations.

JEPQ

Unlike QYLD and JEPI, JEPQ does not explicitly target income consistency. As a result, its monthly distributions have shown more variability, bouncing between highs and lows over its shorter track record.

Consistency Comparison Analysis

Both QYLD and JEPI demonstrate strong income consistency, with their distributions remaining relatively stable over time. JEPQ, on the other hand, shows more variability in its payouts.

It's worth noting that perfect consistency is difficult to achieve with any investment strategy tied to market performance. Investors seeking absolute consistency might consider systematic withdrawal plans rather than relying solely on dividend payments.

Long-Term Growth Potential

While high current income is attractive, long-term growth potential is crucial for maintaining purchasing power and sustaining income over time. Let's assess how these ETFs fare in terms of growth prospects.

JEPI

Since its inception, JEPI's price has risen about 65%, not quite keeping pace with inflation but moving in a positive direction. However, this performance lags significantly behind the Nasdaq-100 index, which has risen nearly 150% over the same period.

JEPI's return pattern is concerning for long-term investors. While total returns including dividends would look better, an investor taking all distributions would have seen declining income over time, even in a very favorable market environment.

QYLD

QYLD has a shorter track record, existing only during an extreme bull market. Since inception, its price has grown only 2% while the Nasdaq-100 is up 15%. This significant underperformance is due to QYLD's high yield strategy, which caps much of the upside potential.

JEPQ

JEPQ also has a limited track record of about one year. It has captured more of the Nasdaq-100's upside than QYLD or JEPI, but still significantly trails the index. Over the same period as QYLD, JEPQ has only slightly outperformed JEPI in terms of price appreciation.

Growth Potential Comparison Analysis

None of these ETFs show strong long-term growth potential if investors are withdrawing all distributions. The funds' strategies of capping upside in exchange for high current yield make it challenging to keep pace with inflation over time.

For investors reinvesting all dividends, JEPQ and JEPI may have a slight edge in growth potential over QYLD due to their less aggressive options writing. However, all three funds are likely to significantly underperform their underlying index in strong bull markets.

It's important to note that these ETFs have only existed during periods of high volatility and interest rates, which boost options premiums. In a more normal market environment, their ability to generate high yields while maintaining growth could be further challenged.

Downside Protection

While covered call strategies give up some upside potential, they are often touted for providing downside protection. Let's examine how these ETFs have performed during market declines.

Recent Downturn Comparisons

Looking at three recent market downturns since QYLD's inception:

1. April 11-19, 2023:

   • JEPI: Smallest decline
   • QYLD: Middle
   • JEPQ: Largest decline (but only by 0.24%)

2. July 10 - August 7, 2023:

   • QYLD: Smallest decline
   • JEPI: Middle (0.14% more than QYLD)
   • JEPQ: Largest decline (about 1% more than others)

3. August 30 - September 6, 2023:

   • JEPI: Smallest decline (-4.02%)
   • QYLD: Middle (-4.8%)
   • JEPQ: Largest decline (-5.3%)

Downside Protection Analysis

While these downturns were relatively minor, some patterns emerge:

• JEPQ consistently showed the largest declines, albeit by small margins.
• QYLD and JEPI were very close in performance, with each outperforming the other slightly in different periods.
• The differences in downside protection were not substantial among the three funds.

It's important to note that these funds have not yet been tested in a prolonged bear market. Their true downside protection capabilities may only become apparent during more severe market stress.

Overall, while covered call strategies can provide some cushioning during market declines, investors should not expect significant downside protection from these ETFs. They will likely still experience substantial losses during major market corrections.

Tax Efficiency

Tax efficiency can significantly impact an investor's real returns, especially for high-yield investments held in taxable accounts. Let's compare the tax implications of QYLD, JEPI, and JEPQ.

JEPI

JEPI's tax efficiency is the lowest among the three funds. Because it uses equity-linked notes (ELNs) for its options strategy, all of the options income is taxed as ordinary income. This means investors pay their highest marginal tax rate on most of JEPI's distributions, rather than the lower qualified dividend or long-term capital gains rates.

JEPQ

JEPQ's tax efficiency is similar to JEPI's. The fund sells options on index-linked products like ETFs, which results in income taxable at ordinary income rates if held for less than one year. This approach does not optimize for tax efficiency.

QYLD

QYLD stands out as the most tax-efficient of the three funds. It employs several strategies to enhance tax efficiency:

1. Individual stock holdings: A small portion of QYLD's income comes from qualified dividends on individual stocks, which are taxed at a maximum rate of 20% (and often lower) for most investors.

2. Index options: By selling options against the Nasdaq-100 index itself (rather than an ETF tracking the index), 60% of QYLD's options income is usually taxed at the lower long-term capital gains rate. Only 40% is taxed at the higher short-term rate.

3. Active tax management: QYLD's managers actively harvest tax losses and pair them with gains, allowing them to classify some distributions as return of capital. This can defer taxes for long-term investors and potentially increase the portion of gains eligible for long-term capital gains treatment.

Tax Efficiency Comparison Analysis

QYLD clearly leads in tax efficiency among these three funds. Its approach can result in significantly lower tax burdens for investors, especially those in higher tax brackets.

JEPI and JEPQ, while offering high yields, are less tax-efficient due to their use of ELNs and index-linked products for options writing. Investors holding these funds in taxable accounts may see a larger portion of their returns lost to taxes.

It's worth noting that tax laws can change, and there are ongoing regulatory discussions that could impact the tax treatment of these strategies. Investors should consult with a tax professional and stay informed about potential changes in tax laws.

Conclusion: Weighing the Trade-offs

After comparing QYLD, JEPI, and JEPQ across income level, consistency, growth potential, downside protection, and tax efficiency, it's clear that each fund has its strengths and weaknesses. Here's a summary of how they stack up:

1. Income Level: QYLD > JEPI > JEPQ
2. Income Consistency: QYLD ≈ JEPI > JEPQ
3. Long-term Growth Potential: JEPQ ≈ JEPI > QYLD (but all lag significantly behind the index)
4. Downside Protection: JEPI ≈ QYLD > JEPQ (marginal differences)
5. Tax Efficiency: QYLD > JEPI ≈ JEPQ

Investors must carefully consider their priorities when choosing between these funds. Those seeking the highest current income might prefer QYLD, while those more concerned with tax efficiency in taxable accounts might also lean towards QYLD. Investors hoping for a balance of income and growth potential might find JEPI or JEPQ more appealing.

However, it's crucial to understand the limitations of these strategies:

1. All three funds have very short track records and have only existed in periods of high volatility and interest rates, which boost options premiums.

2. The underlying strategy of writing slightly out-of-the-money calls on a volatile index like the Nasdaq-100 is inherently risky. It caps much of the upside in strong bull markets while still exposing investors to significant downside risk.

3. None of these funds are likely to provide a sustainably growing income stream that keeps pace with inflation over the long term if investors are withdrawing all distributions.

Investors should be cautious about relying too heavily on these ETFs for retirement income. While they may seem attractive due to their high current yields, their long-term performance in various market conditions remains untested.

A more balanced approach might involve using these funds as a component of a diversified income strategy, rather than as a sole source of retirement income. Combining them with other income-producing assets and growth-oriented investments could help mitigate some of the risks associated with covered call ETFs.

Ultimately, investors must carefully assess their risk tolerance, income needs, and long-term financial goals when considering these ETFs. Consulting with a financial advisor can help in creating a comprehensive investment strategy that aligns with individual circumstances and objectives.

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