YMAX: Call Option 'Diworsification' With Compounded Management Fees

seekingalpha08-01

By confounding income-driven dividends and capital distributions, option-income strategy ETFs are often mismarketed to income investors, leading to risk and return profile misunderstandings.YieldMax ...

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This is not because I do not believe these funds have a place as a potentially valuable portfolio asset. However, I feel they're often mismarketed to an inappropriate investor demographic, namely, income investors. In particular, retired income investors who look for income without capital losses. Further, a significant portion of those who comment regarding these funds often misunderstand the nature of their distributions and their risk and return profile. Most option-income ETFs have abnormally high expense ratios, incentivizing them to create more funds, even when those ETFs may not provide investors with the alpha potential. Thus, there has been an immense proliferation of call-option ETFs over recent years, particularly in the single-company funds offered by YieldMax. One of their more problematic funds may be the \"Universe Fund of Option Income ETF\" (NYSEARCA:YMAX). YMAX is a \"fund of funds\" that invests nearly equal weight in YieldMax's many option-income ETFs. Most of these are single-company ETFs pursuing call-option strategies. However, it even owns its own call-option ETFs on other ETFs, such as the innovation (OARK), which has options on the ETF (ARKK). Technically, that makes YMAX a \"fund of funds of funds\". I do not believe it is problematic due to YieldMax's lack of proper risk information, but it is fundamentally not designed to benefit investors as well as it could. By creating an ETF made mainly of its own ETFs, YieldMax can double-dip its management fee. Further, I'd argue it is not diversified well because most of its holdings are among the most popular mega-cap technology (and other popular non-technology stocks). Indeed, performance metrics show that diversification benefits are better seen in index option ETFs like the Nasdaq 100 (QYLD) and the Russell 2000 (RYLD). Lastly, with the VIX index seemingly rising, investors in YMAX may be due for a more significant correction. Stacking Fees Without Significant Benefit Higher fees do not equal better performance; in most cases, they will drag performance. YMAX's management fee is 29 bps, which is what I'd expect for an option ETF. However, its acquired fund fees and expenses are 99 bps, most of which are fees from its ETFs, allowing it to \"double-dip\" such that its overall expense ratio is a comparatively high 1.29%. Of course, YMAX can point to its 20% dividend yield or 63% 30-day SEC yield to justify its high fee rate, but that may be somewhat misleading. Realistically, there is limited long-term reason why YMAX should see above 7% returns annually as it is an equity-centric fund, and its performance is based on that of equities. The fact is that all of its dividends above ~4-5% (the interest rate on cash in the fund's account) are truly capital distributions from the high performance of the underlying stocks. In most cases, I encourage investors to look to the SEC yield to understand the \"true dividend\" because option premium returns are not dividends, but returns of capital based on appreciation (or, at least, the lack of declines in underlying security values). Thus, the SEC yield for most YieldMax ETFs is 4-5%, based on the Federal Reserve's discount rate determining cash returns. However, YMAX's SEC yield is instead reflective of the underlying assets' distribution yield (returns of capital). Because these are passed through YMAX as a second investment vehicle, they're counted as SEC dividends. Some may note the company's point in its fine print that the \"30-Day SEC Yield represents net investment income, which excludes option income.\" However, because options income on underlying holdings that are passed forward is not counted as option income, though that is the source of most of its \"income.\" Regardless, YMAX's actual performance, even if we account for reinvested distributions, is not that strong. However, likely because it boasts a very high \"dividend,\" its outstanding shares have risen quickly, indicating a decent investor interest in YMAX. See below: Data by YCharts YMAX's holdings are based not on an advanced portfolio allocation model that reduces volatility but instead an equal weight exposure to its most popular products. These include companies such as C3.ai (AI), AMD (AMD), Amazon (AMZN), Apple (AAPL), Coinbase (COIN), Disney (DIS), Meta/Facebook (META), Google (GOOGL), JPMorgan (JPM). Other examples include Tesla (TSLA), Block (SQ), PayPal (PYPL), Netflix (NFLX), and Microsoft (MSFT). There are also option funds on other ETFs like the gold miner fund (GDX), the once-popular ARKK Innovation ETF (ARKK), and the Bitcoin \"strategy\" fund (BITO). The latter three are an example of a \"fund of fund of funds\" situation, which, for me, translates to \"fees on fees on fees.\" There are around 20-22 in total during most periods. The common thread across all these companies is that they're trendy amongst everyday people and, therefore, amongst retail investors who may not be keen on considering valuation, fundamental performance, or macroeconomic factors. YieldMax's goal is to raise its AUM, which, when offering single-company option-strategy ETFs, can only be done by focusing on those with the highest social brand value. Again, YMAX simply invests in its product line; it does not focus on diversification benefits. YMAX is likely far less diversified than the Nasdaq 100 call option ETF (QYLD) and even less as the Russell 2000 equivalent (RYLD) and S&P 500's (XYLD), which are both exposed to a much broader basket of stocks but have more reasonable expense ratios of ~60 bps. This issue is evident in YMAX's systemically elevated volatility compared to the other three. Although YMAX has not traded as long as the others, its beta is likely twice as high, meaning it is more exposed to general market volatility. See below: Data by YCharts YMAX's beta of 1.55X is significant to consider, as that implies it should rise or fall around 1.55% for every 1% change in the S&P 500. Most call option ETFs naturally have beta's below 1X because their focus on selling call options limits their upside potential and gives some buffering against losses, resulting in a slight overall risk reduction (as well as a performance reduction). YMAX's fundamental approach is the same. Its underlying assets sell calls on securities, limiting appreciation potential and offering a premium that could offset some downside losses. However, as I've argued regarding QYLD and others, the actual risk reduction of option premiums is relatively low, particularly considering market risk is often the highest when implied volatility (risk perception in options) is the lowest. Still, YMAX's high volatility and beta ratio indicate it is substantially more volatile than the other option-income ETFs and that its exposure to stock market risk is about twice as high, or ~55% above that of the S&P 500. In other words, YMAX offers little-to-no actual diversification benefits because it is \"diversifying\" amongst an extremely volatile segment of stocks. Yes, YMAX is likely slightly less volatile than most of its underlying holdings, but it is still nowhere near as diversified as QYLD, RYLD, and XYLD. I believe investors are likely better off selecting only those individual YieldMax funds in companies they believe in. I think that all of the holdings in YMAX are in overvalued companies. Potential exceptions are the JPMorgan fund (JPMO) and the Exxon Mobil fund (XOMO); however, those two are both potentially overvalued within their own sectors. Beware of the Rising VIX Ratio All investors in equity-based option-strategy ETFs should closely follow the VIX ratio. When the VIX is low, the implied volatility (expectations of future volatility) of the S&P 500 is low. Implied volatility is a direct measure of premiums on S&P 500 index options. In other words, a low VIX translates to low premium returns on call options (and puts), minimizing YMAX's performance potential. However, a sharp rise in the VIX is also bearish for YMAX. That means the sold options may become more valuable (at least, from a \"vega\" standpoint), usually as the underlying equities decline in value, though volatility goes both ways. As you can see below, spikes in the VIX index, such as the current one, are associated with (post-distribution) losses for YMAX: Data by YCharts Since YMAX has not had a long history, it is worth considering this relationship to the Nasdaq 100's VIX index (the \"VIX\" being an S&P 500 measure), compared to the Nasdaq 100 call option ETF QYLD: Data by YCharts This chart gives us a relatively clear takeaway relevant to all call option-focused strategies: they're best when the VIX is high but falling, and worse when it is low but rising. Around 2016, mid-2020, and late 2022 were significant periods for call option strategies because the VIX was high but falling. That means call option premiums were elevated, giving higher distributions, although the risk declined. Today, I argue the opposite is true. 2024 has seen an abnormally low VIX index in the S&P 500 and Nasdaq 100 as mega-cap stocks have risen to all-time highs. Thus, investor risk perception (and hedging activity) has been extremely low, limiting premium returns on call options. However, with the recent mega-cap correction, the VIX has risen quickly. It still has a long way to go if it returns to the 2022 level, due perhaps to an economic slowdown, thus giving virtually all call option funds a poor risk-reward profile. Again, investors could look through YieldMax's products for specific stocks with elevated implied volatility levels, and they may avoid this risk factor. However, because YMAX is, to me, \"diworsified\" into mega-caps, I believe its exposure to a rising VIX is more significant than it is for the index call option ETFs. The Bottom Line Overall, I can't help but believe YMAX is a silly investment product created to increase YieldMax's income and not necessarily benefit investors. Again, YieldMax is transparent regarding YMAX's risks and necessary fund information. My only gripe is that its SEC yield is somewhat misleading by counting option income as investment income, though that is likely how the SEC counts it since the distributions are passed through. However, in my view, if YieldMax truly wanted to create a diversified option-strategy ETF that truly benefits investors, it could pursue an intelligent allocation model between commodities, stocks (of various sizes and industries), bonds, and even currencies. Such a multi-asset option strategy fund could be a great tool. However, YMAX is nothing close to that. Instead, it is a pool of its own products, allowing it to double-dip management fees without creating a strategy that reduces risk. Instead, its strategy appears to elevate YMAX's risk compared to the more established call option index funds. I am also bearish on YMAX due to its excess concentration in mega-caps with high social popularity that, I feel, are overvalued and due for a more significant correction. My macroeconomic and monetary outlook plays a role in that view. Although I believe QYLD, RYLD, and XYLD are superior to YMAX due to their lower beta ratios and volatility, my outlook on them is also bearish due to my expectation of a rising VIX ratio. It is perfectly reasonable to disagree with my view, as it may be that the recent VIX spike will soon reverse, offering YMAX and other option-income funds higher relative performance. To me, the VIX ratio is due to rise due to a \"hard landing\" in the monetary environment. However, that remains undetermined, with many reasonably expecting a soft landing after the recent GDP report.  Still, even if you have a bullish outlook on call option strategy funds, I think YMAX is a poor choice. Its fees are compounded, while it lacks diversification value. Those with a bullish outlook may find better risk-adjusted returns by investing in QYLD, RYLD, or XYLD while perhaps owning a small portion of specific YieldMax ETFs in companies they truly believe in. For me, the YieldMax Exxon Mobil fund (XOMO) is probably my favorite due to XOM's relatively low valuation. I also find the covered put (short-sell) Tesla fund (CRSH) interesting (which is not part of YMAX's holdings, though it owns a bullish TSLA position), though I'd probably just buy put options on TSLA.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"-1","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":"4.29.2","shortVersion":"4.29.2","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/2456854684"}