FEPI: Good Covered Call ETF, But Better Choices Are Out There

seekingalpha03-18

FEPI is a covered call ETF focusing on select growth and tech stocks.Although the fund offers investors a sky-high 25.9% yield and has outperformed since inception, risks seem excessive.JEPQ is a ...

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It sells out of the money call options on its holdings, capping potential upside, but boosting its distribution rate to a whopping 25.9%, annualized. Although the fund seems like a reasonable investment opportunity, I believe that the JPMorgan Nasdaq Equity Premium Income ETF's (JEPQ) offers a similar, slightly stronger, value proposition. JEPQ focuses on tech companies too, but is more diversified, less risky, and a bit cheaper. As such, I would not be investing in FEPI, and would choose JEPQ instead. JEPQ - Overview and Analysis I generally start my articles by detailing a fund's strategy and portfolio. JEPQ has a handy infographic doing just that. JEPQ Seems simple enough. Let's have a closer look at the points above. Big Tech Exposure FEPI focuses on tech and growth companies. Specific holdings are as follows. FEPI - Table by Author FEPI claims that its significant tech exposure is a positive, but I'm much more conflicted about the situation. One of the biggest benefits of significant tech exposure, especially to the more innovative high-growth companies, is the possibility of outsized capital gains and returns. As an example, Nvidia's share price is up close to 2,000% these past five years, Tesla is up 790%. Other companies and industries offer strong potential returns too, but tech and growth generally has more potential. Data by YCharts Importantly, FEPI's call options cap upside potential, so the fund will almost certainly never see outsized capital gains close to the above. Significant capital gains are somewhere between impossible and extremely unlikely, although smaller gains are possible. As the fund does not provide specific, detailed information about its option strategy, it is impossible for me to quantify these. Still, the general gist of these seems clear enough. As an example of the above, the fund's share price is slightly down YTD. Data by YCharts Even though its underlying holdings have seen their share prices increase by 10.0% on average. Said average was almost entirely due to the outsized gains experienced by Nvidia, Meta, and AMD (AMD). Data by YCharts FEPI's capital gains were much lower than those of its underlying holdings, in-line with expectations. Expect similar results moving forward. This significantly blunts the positive impact of investing in tech and growth. If investing in Nvidia can't lead to significant gains, might as well invest in safer, cheaper companies. Same idea for FEPI. Importantly, FEPI's call options have no impact on the fund's downside potential. Expect similar capital losses to those of its underlying holdings during downturns, recessions, and bear markets. FEPI's holdings are much riskier than average, with above-average drawdowns too. Compare Nvidia, Tesla, and AMD drawdowns with the S&P 500, for instance. Data by YCharts FEPI is a relatively young fund, with inception in October 2023, so it has yet to experience a significant drawdown. Still, considering the above, losses could be staggering. This is an important, self-evident negative, and one which is amplified by the fund's below-average capital gains. FEPI's share price can easily go down, but going up is much more difficult, which means recovering from losses is difficult too. Lots of covered call ETFs suffer from these issues, including the suite of Global X covered call ETFs, all of which have seen steadily declining share prices since inception. Data by YCharts FEPI should suffer from these issues too, at least long-term. As the fund focuses on particularly risky companies with sky-high drawdowns, losses could be incredibly significant as well. On a more positive note, FEPI's share price is up since inception, but the fund is young, and has only existed during a significant, almost unprecedented tech bull market. In my opinion, it is incredibly important for covered call funds to reduce risk and drawdowns. FEPI focusing on tech and growth companies should have the opposite effect, a significant negative for the fund, and a deal-breaker for me personally. Potential Income Generation FEPI's covered call options generate significant premiums, which are then distributed to shareholders. Annualizing the fund's latest monthly dividend payment nets me a 25.9% distribution yield, sky-high on an absolute basis, and significantly higher than that of most equity and covered call funds. Data by YCharts FEPI's yield is much higher than the covered call average as it focuses on volatile tech and growth companies, with expensive options. Remember, by selling these options the fund is capping its upside potential. For companies like Nvidia and Tesla, upside is sky-high, so selling it is quite pricey. FEPI's strong yield is a significant benefit for the fund and its shareholders. On a more negative note, distributions are unlikely to be long-term sustainable, as drawdowns lead to lower asset values / options sold. Distributions have been sustained since inception, however, but the fund is really young, and I am quite confident that these will decline long-term. Potential Downside Buffer FEPI's strong distribution yield is a consistent benefit for the fund, but its particularly impactful during downturns and recessions. Expect the fund to outperform relative to its underlying holdings during these. As the fund is quite young it has yet to experience a downturn or recession, but most other covered call funds have outperformed the S&P 500 during these, including during 2022. Data by YCharts Note that FEPI's distributions should lead to outperformance relative to the fund's underlying holdings. There is no guarantee that the fund itself will outperform broader equity indexes, including the S&P 500. As an example, the Global X NASDAQ 100 Covered Call ETF (QYLD) outperformed the Nasdaq-100, underperformed the S&P 500, during 2022. FEPI should probably have seen similar results during said year, due to focusing heavily on tech. Data by YCharts In my opinion, although FEPI's strong distributions and potential downside buffer are important benefits, the significant tech exposure and lack of diversification are excessive risks, and deal-breakers to me. As a final point, I am aware that these issues have yet to be reflected in the fund's performance, but FEPI is very young, and I do stand by my analysis. FEPI - Other Considerations As an aside, and in my opinion, option strategies focusing on specific stocks should be evaluated on their specifics. Selling calls on Nvidia might be a good idea depending on their prices, implied volatility, time to expiration, etc. Corollary of this is that strategies such as those employed by FEPI are inadequate, as it is impossible for investors to properly analyze these. The fund itself rarely does either, opting for consistently selling calls regardless of underlying market conditions. In my opinion, investors wishing exposure to these strategies should run them themselves, and only do so when conditions seem particularly ripe. These issues do somewhat impact similar strategies focusing on equity indexes, including the S&P 500, but by much less, as these broader indexes are less volatile, and their option markets more liquid. Conclusion  FEPI is a covered call ETF focusing on select tech and growth companies. As FEPI is excessively concentrated, and with significant downside risk, I would not invest in the fund.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2420956475"}