JPMorgan Equity Premium Income ETF (JEPI) is a high income ETF that pays 10.98% (TTM) dividend yield, by using a mix of approaches of owning dividend paying stocks and selling covered call options and using Equity Linked Notes. This allows the ETF to pay dividends yielding double digits, and looks like an attractive investment for investors who are seeking immediate cash flows from their investments. The expense ratio for this ETF is 0.35%, which is not too bad considering the fund manager is actively managing the fund. Other actively managed funds have expense ratios above 0.75%.
JEPI pays 10.98% dividend yield
Let's take a look why high yielding dividend ETFs tend to underperform the broader market when the bull market is in play.
Reduced dividend income
Looking at the dividend payout history, the dividends have dropped in the first half of 2023. Let's explore why the dividend payout is falling, especially since we are back in a bull market.
Covered call options
One of the strategies of JEPI is by selling covered call options. A covered call option is an option contract in which the option seller owns the underlying stock or ETF, and the option seller sells to a third party or buyer, which gives the buyer the right to purchase the underlying at an agreed upon price (or strike) by an agreed upon date (expiration date). For starters, 1 option contract equals to 100 shares.
When selling an option, the seller collects a premium. Assuming the seller is selling call options on Apple stock, on the expiration date of the third Friday of July, on July 21, 2023.
Call options table Apple, expiring on Jul 21, 2023
If the seller believes Apple is going to fall or stay at the current stock price, the seller can sell a call at the strike price of $190, and collect a premium of $310 ($3.10 x 100 shares in an option contract). If by July 21, the price of Apple does not go above $190, the seller gets to keep the premium. However if the price goes above $190, the seller has to sell 100 shares at $190 per share. Hence the seller needs to own 100 shares, hence known as a covered call. Here the disadvantage is the seller now will cap his maximum returns as he will not participate in the stock run up if it goes above $190.
To avoid such limits on the maximum potential returns, the seller usually goes for a higher strike price, in exchange for lesser premium. From the option table, a strike of $190 collects $310, while strike of $195 collects only $110.
Long term caveat
During bull markets, the yield on JEPI tends to decrease, as the markets become less volatile. The CBOE Volatility Index (VIX) is a measure of volatility in the market, and the VIX currently is below 15. Compared to 2022, when the VIX was in the 25-30 range, and even at times hitting 35. VIX has a huge impact on option premiums, so during bear markets, option premiums are higher, while during bull markets, option premiums are lower.
As a result, the dividend payments are expected to fall, making it less attractive to investors seeking high income during the bull market.
JEPI outperformed SPY from Jan 1, 2023 to Oct 31, 2023 during the bear market
From the comparison above, during the bear market of 2022, JEPI outperformed the SPY, the ETF that tracks the S&P 500.
However, looking at the past 3 year history, it clearly shows that JEPI will underperform during bull markets, due to reduced dividend income from selling call options, which are a result of reduced premiums collected and a risk of capping your returns if the call strike price is reached.
JEPI underperformed SPY in the last 3 years.
Key summary
When investing in a high equity income ETF like JEPI, investors often look at the high yield and monthly dividend payments and are instantly attracted. During a bear market, it is a great feeling to collect high dividends, especially when the broader market had a drawdown of more than 20%. However when the bull market returns, due to its strategy of selling covered call options, it will always underperform the SPY. Indeed if short term income is what the investor is focused on, indeed JEPI is good for those who seek short term returns. For investors with a longer time horizon, JEPI (with expense ratio 0.35%) is definitely a bad idea, when compared to the SPY (with expense ratio of 0.09%). Even the QQQ (expense ratio 0.20%) which tracks the Nasdaq-100 index is a better option, although Nasdaq-100 will have a steeper drawdown during bear markets.
Comments
Many investors buy stocks with a solid balance sheet which pay dividends and with the prospect of consistently growing the dividend. In addition to the realized cash the investor usually has a capital gain in the stock price. Morgan is one such stock.
I think we will see a nice breakout in the near future, maybe a couple catalyst coming hopefully raise dividends and repurchase shares to follow by good earnings report
If you'd been holding shares of JPM since this time last year, you would be feeling as silly to yourself as you appear to others.