YieldMax Investments: A Deep Dive into High-Yield Opportunities
So, I’ve been studying options trading since I learned that it’s possible to return up to ten percent income, and I was thinking of using covered calls. However, to try the investment I wanted, the buy-in would be around fifty thousand dollars, which is doable but makes me a bit nervous as a beginner to put that much up front. Then I found out about the Poor Man’s Covered Call strategy and realised I could replace the stock with a LEAP, so the buy-in would be around 5k rather than 50k—much better. But wait, then I found out there are ETF investments where someone experienced will employ the strategies for me, with a buy-in starting from just fifty bucks and a one percent fee! What’s not to like?
For covered calls, I found SPYI, which writes covered calls and buys the underlying (aiming for around 10% annual returns), and YieldMax uses synthetic longs (without the underlying) on a range of assets. The downsides are that SPYI will have slightly capped growth, while YieldMax investments will erode over time. However, for me, I’m under a tax regime that allows me a lot more income than gain before I’m taxed, and since I’m living on this income, it makes sense for me. I’ve discussed SPYI elsewhere, but in this article, I want to explain YieldMax in more detail.
What Are YieldMax ETFs?
YieldMax ETFs are designed to provide investors with high monthly income through an options-based strategy. These funds sell call options on various underlying assets, such as stocks or other securities, to generate premium income. The key difference here is that YieldMax ETFs don’t actually own the assets. Instead, they use a synthetic position—meaning they create exposure through derivatives.
This strategy lets them generate substantial premiums, which is why the yields on these ETFs can be very attractive. In some cases, you might see yields of 20% or more annually. However, while this may sound like an ideal way to generate income, there’s a catch. The fund’s strategy is heavily reliant on short-term options trading and doesn’t give investors direct exposure to the underlying assets. As a result, the fund’s ability to appreciate in value is limited, and the net asset value (NAV) could erode over time.
The Synthetic Covered Call Strategy
The synthetic covered call strategy is at the heart of how YieldMax works. Normally, when you write a covered call, you own the underlying stock, and you sell calls against that position to generate income. In YieldMax, however, the fund doesn’t own the underlying stock. Instead, it creates a synthetic position using short-term call options and other derivatives. By selling options on these synthetic positions, the fund collects premiums, which form the bulk of the income generated.
While this approach generates a reliable income stream, it limits the potential for capital gains because the fund doesn’t hold the underlying asset. Unlike traditional covered calls, where stock appreciation could offset the erosion of NAV, the synthetic covered call approach doesn’t benefit from any potential long-term growth in the underlying stocks.
Asset Erosion and Risk
One of the major risks of investing in YieldMax ETFs is the potential for asset erosion. Because the fund pays out a large portion of its income to investors, the NAV of the fund can decrease over time. This happens each time the fund distributes premiums from selling options, leading to a steady decline in the value of the underlying assets.
While some might find the income attractive, it’s essential to recognise that this approach can result in a decline in the NAV, especially if the assets don’t appreciate at a rate that offsets the erosion. The degree of erosion depends on several factors, including the volatility of the underlying assets. For example, funds focused on volatile stocks may experience more significant erosion as the underlying assets fluctuate in price.
In terms of numbers, YieldMax ETFs have been known to experience declines in NAV ranging from 5% to 60% annually, depending on the volatility and performance of the underlying stocks. This level of erosion could be significant, particularly in more volatile markets, so it’s important to consider the trade-off between high yields and long-term erosion.
Volatility and High Yield: The Double-Edged Sword
The high yields offered by YieldMax ETFs are made possible by their use of volatile stocks. Volatility drives up the premiums on options, which allows the fund to generate large amounts of income. Stocks with greater price swings, like Tesla or Nvidia, can offer much larger premiums for call options, meaning the fund can distribute higher yields to investors.
However, this volatility also introduces more risk. If the stock price moves sharply in the wrong direction, the value of the synthetic position could drop significantly. And because YieldMax doesn’t hold the underlying assets, the fund has no way to recover from such declines. The potential for downside risk is something that investors should keep in mind, as it can offset the high income generated by the options premiums.
While volatility provides the opportunity for larger premiums, it also creates the risk that the underlying asset could lose value without the potential for long-term recovery. This is why YieldMax focuses on stocks with high volatility—it allows the fund to capture large premiums but also exposes investors to more risk.
YieldMax vs. Other Income Strategies
If you’re familiar with the poor man’s covered call (PMCC), you might be wondering how it compares to YieldMax. The key difference between the two strategies is the underlying exposure. In a traditional PMCC, you hold a long-term LEAPS call option on the stock, which gives you exposure to the asset’s performance over time. You then sell short-term calls against the LEAPS to generate income.
With YieldMax, the fund doesn’t hold the underlying asset or long-term options. Instead, it relies on short-term options and synthetic positions to generate income. While this allows for high yields, it limits the potential for long-term capital growth. The PMCC strategy, on the other hand, allows you to benefit from both the income generated by the options and the potential for long-term growth in the underlying asset.
If you’re looking for a more traditional, long-term strategy with potential for capital gains, the PMCC might be a better fit. However, if you’re seeking high, consistent income and are comfortable with the risks of synthetic options, YieldMax could be a suitable alternative.
Fees and Expense Ratios
Another consideration with YieldMax ETFs is the expense ratio. Most of these funds have an expense ratio of around 0.99%, which is relatively low compared to many actively managed funds. However, this fee is still something to keep in mind, as it will be deducted from the fund’s returns over time. Despite the low fees, the main cost is the erosion of the NAV due to the high payouts.
The expense ratio isn’t particularly high, but when you combine it with the potential erosion of value from frequent distributions, it’s essential to consider whether the strategy fits your goals.
Final Thoughts: Should You Invest in YieldMax ETFs?
YieldMax ETFs offer an attractive income stream, especially for those looking for high, regular payouts. However, this strategy comes with risks, particularly around asset erosion and the volatility of the underlying assets. If you’re looking for consistent income and are willing to accept the potential for value erosion, YieldMax could be a good fit.
For those who are more risk-averse or looking for long-term growth, strategies like the poor man’s covered call (PMCC) may be more appropriate. The key is understanding your investment goals and risk tolerance before diving into either strategy.