SPYI: Continues To Perform As Expected

seekingalpha06-24

The markets have been consistently hitting new highs, with the S&P 500 up 56% and the Nasdaq up 86% in less than 2 years.Neos S&P 500 High Income ETF uses covered calls to participate in market gains ...

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There is a joke going around saying that \"markets make 5 new all-time highs in a good week, but only 2-3 new all-time highs in a bad week\". The S&P 500 is now up 56% and the Nasdaq is up 86% in less than 2 years since the bottom of October 2022. Markets seem to keep rallying higher and higher without making any pullbacks, experiencing corrections or profit-taking seems to be almost completely non-existent. Many investors are scratching their heads about what's going on and others are looking for alternative funds to participate in at least some of the market performance while reducing their risk, and one of these funds is Neos S&P 500 High Income ETF (BATS:SPYI). Data by YCharts Overview of the Fund's Strategy  The fund holds shares of S&P 500 index and writes covered calls against its holdings. What makes this fund different from many other covered call funds is that it tries to participate in at least some of the price appreciation by doing one of two things: 1) either write call options that are out of money or 2) writing call spreads instead of call options. Thus, the fund's performance in the last couple of years is better than some of its peers. Data by YCharts I originally covered this fund back in early 2023 in an article titled SPYI Is An Interesting Income Play. Back then, the fund was purely doing covered call spreads, but since then, it shifted its strategy to include a mix of covered call spreads and writing out of money call options. Interestingly enough, when I look at the fund's current holdings, the only option plays I am seeing are two deeply in the money options. One is an SP500 option block at a strike price of 5,320 with an expiration date of 7/19 and another is an option block with the same expiration date but with a strike price of 5,370. Considering that the S&P 500 currently sits at 5,464, both options are in the money. I find it interesting that the fund deviated from its usual practice of selling covered call spreads and instead went with selling covered calls at such low strike prices. We know that this is an actively managed fund, so perhaps the management team of the fund is not particularly bullish about stocks in the near term. SPYI's current option holdings (NEOS Funds) Distributions The fund is mainly considered an income play, and it has a very high distribution rate of 1% per month even with VIX sitting at super low levels. Other covered call funds such as Global X S&P 500 Covered Call ETF (XYLD) and JPMorgan Equity Premium Income ETF (JEPI) cut their distributions significantly in the last year because of falling VIX while this fund maintained its distributions at the same level as when VIX was a lot higher. You may be wondering how this is possible. This is because different funds have different policies in terms of how much they distribute. Some funds only distribute the time value portion of their covered call gains, so their distributions will fluctuate up and down depending on where VIX is. SPYI distributes about 1% per month regardless of how much time value it collected from its covered calls, so the fund actually distributes a mix of its covered call gains as well as capital gains, so not all the distributions come from selling covered calls. This is especially true considering that the fund typically sells out of money calls, which come with less premium but allow more share price upside. Data by YCharts This is most likely sustainable during a bull market. For example, in the last 12 months, the fund's NAV is up 3.59% even after distributing about 12% in dividend distributions. In comparison, XYLD was barely flat and JEPI was up only 2.69% despite the two having lower distributions. If we were in a bear market, this might have looked differently. Since markets tend to be in a bull market far more often than in a bear market, this should work fine in most typical market conditions, but it's impossible to tell what the markets have in store for us in the future. Data by YCharts Risks The biggest risk for funds like this is a prolonged bear market. It would be particularly risky if the market was highly volatile, swinging up and down in a W shaped fashion. Why is that? Because covered call funds tend to give up upside in stocks in exchange for options premium. What it means is that they typically participate in most of the downside movement but very little of the upside movement. For example, if you buy a stock for $100 and sell monthly calls for a premium of $1 at $105, you give up any upside that could happen above and beyond $105, but you take the risk of $99 in return ($100 minus $1 of premium). Doing this once or twice would be fine, but what if you have to do this month after month while the market swings up and down? Let's say one month the market drops -10% and the next month it climbs 10% and the following month it drops -10% again, and it climbs 10% again. This is an extreme scenario that is unlikely to happen, but if a scenario like this were to happen, a covered call fund would suffer about 8-9% of a drop in down months and gain only about 5-6% in up months. Repeat this enough times, and you see significant NAV decay, even if the market itself might remain range bound during this time in a W shaped fashion. Luckily, these scenarios don't happen very often and when they do, they don't happen as violently as I described above, but nothing is guaranteed in this market, and you should be prepared against all cases, no matter how unlikely they may appear. In the long run, markets are up more often than they are down. We can say this at least for the S&P 500 index. Since covered call funds tend to underperform the overall market during bull runs, it is likely that this fund will also underperform the overall market in the long run, but many people are fine with this because they are more focused on generating income than total returns. Some people also hold these types of funds as a \"hedge\" in case the market's performance is weak or flattish in the next several years. In the past, markets have had many periods of \"lost decades\" where returns were very weak for many years to come. For example, both S&P 500 and Nasdaq were virtually flat from 2000 to 2013 and many people expect a similar scenario in the next 10-15 years due to high valuations of the market today so if we had a \"lost decade\" type of scenario, a fund like this might have a good payout. Like I said above, the fund is actively managed, and its management team will adjust strike prices based on how bullish or bearish they feel at the time, so investors who are buying this fund should put their trust into the fund's management and their ability to navigate different market scenarios. Often times we see certain funds perform very well under certain scenarios but very bad under other scenarios, and you don't want to be caught off-guard if market conditions change. This fund hasn't been around for very long, so we don't know how exactly it will perform under different scenarios, which could be another risk to consider with it.  All in all, this is a decent fund that continues to do what it promised investors it was going to do, which is, generate decent income from selling covered calls while not completely giving up price appreciation either. So far, it's been doing its job, and let's hope that it continues to do so for years to come. Also, I must add that this fund's creators recently added a sister fund which follows the same strategy but uses Nasdaq instead of S&P 500, and it's worth taking a look at too. It's called NEOS NASDAQ-100 High Income ETF (QQQI) which I, personally, hold in my portfolio.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"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":"4.29.3","shortVersion":"4.29.3","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/2445212073"}