JEPQ Offers A Hiding Place Amid Market Volatility

seekingalpha04-23

Market volatility has returned and could persist with our ongoing macroeconomic and geopolitical risks.JEPQ offers an effective hedge against such volatility.Its dividend yield of 9.5% provides ...

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MORGAN NASDAQ EQUITY PREMIUM INCOME ETF","VIXY":"波动率短期期货指数ETF","TQQQ":"纳指三倍做多ETF"},"translate_title":"JEPQ在市场波动中提供了一个藏身之处","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"JEPQ":1,"US7Y.BOND":0.9,"US6M.BOND":0.9,"US5Y.BOND":0.9,"US3Y.BOND":0.9,"US30Y.BOND":0.9,"US2Y.BOND":0.9,"US12M.BOND":0.9,"US10Y.BOND":0.9,"VXX":0.88,"TVIX":0.88,".IXIC":0.8,"US912797FH58.BOND":0.6,"VIXY":0.6,"UVXY":0.6,"US912797HH31.BOND":0.6,"US912797HG57.BOND":0.6,"US912797HE00.BOND":0.6,"US912797GW17.BOND":0.6,"US912797GL51.BOND":0.6,"US912797GK78.BOND":0.6,"US912797GB79.BOND":0.6,"US912797FS14.BOND":0.6,"SVXY":0.6,"US912796CX52.BOND":0.6,"MNQmain":0.6,"NQmain":0.6,"VIXmain":0.6,"PSQ":0.6,"QID":0.6,"QLD":0.6,"QQQ":0.6,"SQQQ":0.6,"TQQQ":0.6},"content_text":"Market volatility has returned and could persist with our ongoing macroeconomic and geopolitical risks.JEPQ offers an effective hedge against such volatility.Its dividend yield of 9.5% provides current income and downside protection.Market volatility can boost its option income, potentially leading to increased payouts for investors.Finally, its holdings are less top-heavy than the Nasdaq 100 Index, thus reducing correlation to the broader market.   Claudiad/E+ via Getty Images JEPQ yields 9.5% I last wrote about the JPMorgan Nasdaq Equity Premium Income ETF (NASDAQ:JEPQ) back in December 2023 (see the chart below). In that article, I argued for a HOLD thesis mainly because of two considerations. First, the yield back then (around 10%) was not as attractive as it seemed on the surface when benchmarked against other options. Some of the benchmarks I used include risk-free rates and the earning yield from the overall equity market. Second, the volatility index was very quiet at that time, and I expect the low volatility to reduce its option premium income. Seeking Alpha Fast-forward to now, all of the considerations above have run their course. The 10-year treasury rates were around 5% and have decreased to 4.6% as of this writing, the earnings yield from the equity market has also fallen from the December level to a near all-time low currently, and the market volatility has returned. Given these changes, the thesis of this article is to argue for an upgrade of the rating to BUY under current market conditions. In the remainder of this article, I will elaborate on the impacts of these changes on its dividend yield, its valuation multiples relative to the overall market, and also the potential option premium boost due to market volatility. First, let’s start with the yield. The chart below (top panel) shows the dividend yield for JEPQ over the past year. As seen, the fund is yielding about 9.5% currently. Such a yield is attractive in both absolute and relative terms. It can provide a sizable current income and also a good degree of downside protection should the overall market correct further. Looking more carefully at the chart, we can see that the ETF yielded around an average of ~10% in late 2023 when my last article was published, slightly higher than its current yield. However, in my view, a yield of ~10% when risk-free rates were ~5% is equivalent to a yield of 9.5% when risk-free rates are ~4.6% because the yield spreads are about the same (5% vs 4.9%). Also note the decline of the yield since last October to the current level, as argued in my earlier article. The decline was largely caused by two factors, in my view. First, its price advancements naturally drive down the yield. Second, JEPQ uses covered calls to generate the bulk of the yield, and this strategy’s income correlates with market volatility. As seen in the bottom panel of the chart, the decrease in its yield in 2024 so far was accompanied by some of the quietest volatilities. Now with the return of market volatility, I see good odds for its income to get an extra boost and will elaborate more on this later. Seeking Alpha JEPQ: basic information Before going any further, let me provide some basic information about the fund for readers new to it. The fund description provides a good summary and I will just quote it below. The highlights were added by me to emphasize the parts that are of immediate relevance to this article. JEPQ generates income through a combination of selling options and investing in U.S. large-cap growth stocks, seeking to deliver a monthly income stream from associated option premiums and stock dividends. It seeks to deliver a significant portion of the returns associated with the Nasdaq 100 Index with less volatility. It constructs a long equity portfolio through a proprietary data science-driven investment approach designed to drive portfolio allocations while maximizing risk-adjusted expected returns. Next, I will elaborate on the implications of these features under today’s market conditions. JEPQ fund description  Holdings and valuation The chart below summarizes the top 10 holdings of the fund. As seen, the top holdings include some of the familiar names in the Nasdaq 100 Index top 10 such as Microsoft Corp Common (7.4%), Apple Inc. (5.6%), etc. However, the weights are quite different and JEPQ is much less top-heavy than the Nasdaq 100 Index. JEPQ fund description  Such differences are due to the selection algorithm mentioned above. The algorithm attempts to maximize risk-adjusted expected returns. Since it is proprietary, I can only speculate what metrics it tries to optimize. Judging by the holdings shown above and their characteristics (see the next chart below), I believe the algorithm A) does not follow a market-cap-based allocation, and B) is more oriented towards consistency. I believe both features are timely for the markets we are in today. JEPQ's holdings offer several key advantages in my view. With a less top-heavy allocation, JEPQ is less reliant on the performance of a few mega-caps – which is the key risk in the current market in my view. Currently, both the Nasdaq 100 and SP500 Index are too dominated by a few tech giants priced at very expensive P/E multiples in my view. With more diversified holdings, JEPQ could also lower its correlation to the overall market. Combined with its lower standard deviation (see the next chart below), this could cause the price of JEPQ to NOT move in lockstep with the broader market, thus reducing overall portfolio volatility for investors. JEPQ fund description  Role of volatility Finally, let me revisit the role of volatility. The chart below shows the volatility index (“VIX”) in the past year. As aforementioned, the income generated by its option overlay correlates with market volatility. As seen, in the second half of 2023, volatility was relatively high, with an average of around 16x and a peak of 22x. To better contextualize things, a VIX of 22x corresponded to a 73% percentile historically. Such higher volatilities were a main driver for its ~12% yield during that period. Then the volatility quieted dramatically in 2024 and the low volatility remained tilled recently. The VIX averaged around 14x in the first few months of 2024 as seen. Again, to provide a broader context, a VIX Of 14x corresponds to a 30% percentile historically. Now the market volatility has returned and VIX has increased to the current level of 18.3x. Furthermore, I see good odds for such elevated volatility to remain in the near future due to the heightened geopolitical risks, CPI data that indicated persisting inflation, etc. Combined with JEPQ’s recent price corrections, I won’t be surprised that investors enjoy much higher payouts in the next 1-2 years. Seeking Alpha Other risks and final thoughts JEPQ faces similar risks that are common to other funds that use the covered-call strategy. These risks of the sensitivity of their premium income with respect to volatility and their capped upside potential. When a fund sells covered calls and if the stock price rises significantly above the strike price of the call option sold, the fund will be forced to sell your shares at the strike price, missing out on the additional profits. Two risks that are more particular to JEPQ involve its turnover rates and P/E in my view. As seen in the chart below, as of March 31, 2024, the P/E ratio of JEPQ was 27.04, slightly higher than that of the Nasdaq 100 Index (25.5x). Although, the fund features a slightly higher EPS growth rate (11.98% vs. 10.38% as seen) to partially offset the P/E premium. The fund’s turnover rate was 162% over the past 12 months. Such a high turnover rate could cause tax headwinds. All told, I think the benefits outweigh the risks under the current market conditions. Thus, my thesis is that JEPQ presents a BUY opportunity, especially viewed as a hedge against market volatility. With a current yield of 9.5%, JEPQ offers an attractive income source and potential downside protection. Also, its more diversified holdings reduce reliance on a few mega-cap stocks, thereby lowering correlation with the broader market. Finally, I expect the fund's income to benefit from heightened market volatility, potentially resulting in increased payouts for investors.  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