The Defiance Nasdaq 100 Enhanced Options Income ETF (NASDAQ:QQQY) is a new ETF launched to offer income generation and possible capital appreciation, with a strategy focusing on the selling of at-the-money options. The income generation comes from the options premium collected but can have negative impacts from movements in the underlying index. The issue with QQQY it’s just getting started. Since it kicked off in September 2023, we haven’t seen enough to say if it’s a solid bet. So far, it’s not turning heads with its performance. I believe it’s best to wait and watch QQQY’s performance over 2024 before allocating capital to this new strategy.
QQQY offers a unique approach to income generation and exposure to the Nasdaq-100 Index. Managed by Tidal Investments LLC and part of the Defiance suite of products, this actively managed ETF was launched on September 14, 2023, and trades on the NASDAQ exchange. QQQY stands out for its innovative strategy of actively placing bullish bets on the Nasdaq-100 Index through daily selling of at-the-money or slightly in-the-money put options that expire the next trading day. This zero days to expiration (0DTE) put option writing strategy is designed to generate income from option premiums, profitable if the Nasdaq-100 Index moves higher.
While QQQY aims for limited exposure to the Nasdaq-100 Index’s performance, it does not directly participate in the full gains of the index, differing from a traditional index-tracking ETF. The fund predominantly holds short-term US Treasury securities to serve as collateral for its short-put option positions, providing a degree of security and liquidity crucial for managing the inherent risks associated with its options strategy.
A notable aspect of QQQY is its risk and return profile, marked by potential volatility due to its daily options strategy. This approach results in significant daily performance fluctuations, making QQQY a more volatile investment compared to standard equity ETFs. Additionally, distributions from QQQY are taxed at the higher ordinary income rate, which is an important consideration for investors mindful of the tax implications on their returns.
QQQY adopts a distinctive strategy, focusing on generating income through a novel options trading approach. Managed by Tidal Investments LLC, this ETF is uniquely positioned as the first to employ a daily options strategy, specifically targeting the Nasdaq-100 Index. The core of QQQY’s investment approach involves the aggressive use of a 0DTE (zero days to expiration) put option writing strategy. This entails the daily selling of Nasdaq-100 Index put options that are either at the money or up to 5% in the money, with these options expiring the next trading day. This bullish strategy hinges on the Nasdaq-100 Index moving higher, enabling QQQY to collect premiums from the options it writes.
While QQQY’s strategy aims for limited exposure to the Nasdaq-100 Index’s performance, it does not seek to directly replicate the index’s gains. A significant portion of the fund’s portfolio is invested in short-term US Treasury securities, serving a dual role. Firstly, these securities provide a stable and secure investment component. Secondly, they act as collateral for the short put option positions, playing a crucial role in the fund’s risk management strategy.
As an actively managed fund, QQQY offers flexibility, with its portfolio being frequently adjusted in response to changing market conditions and the fund manager’s analysis. This active management approach is critical in navigating the complexities of options trading and market dynamics. The distributions from QQQY, derived from its options strategy, are subject to taxation at the higher ordinary income rate, an important factor for investors to consider in terms of after-tax returns.
QQQY’s daily use of options sets it apart in the ETF marketplace, providing an alternative for investors seeking exposure to the technology-driven Nasdaq-100 Index while also pursuing a strategy for monthly income generation.
This approach, however, results in a unique risk and return profile for the fund, characterized by potential daily fluctuations in performance, making it distinct from more traditional equity ETFs, with significantly more risk to the downside.
Selling Put Options at the Money at Expiry
Selling at-the-money options is a central component of the investment strategy employed by the Defiance Nasdaq 100 Enhanced Options Income ETF. This method involves writing put options on a stock or index where the strike price is approximately equal to the current market price. In the case of QQQY, these options are written on the Nasdaq-100 Index. The critical aspect of this approach is the immediate income generation from the premiums received when these options are sold. This strategy is inherently bullish, as it profits when the underlying index remains stable or increases in value.
A key factor in this strategy is the concept of theta, or time decay, which plays a significant role in options trading. Theta represents the rate at which an option’s value decreases over time, with all other factors being equal. Essentially, as the expiration date of an option approaches, its value diminishes, assuming the price of the underlying asset remains unchanged. This time decay accelerates as the option nears its expiration.
In QQQY’s strategy of selling at-the-money options with a 0DTE (zero days to expiration), the fund capitalizes on this time decay. Since the options are written to expire the next trading day, the theta is exceptionally high, leading to a rapid loss of value in these options if the Nasdaq-100 Index does not move significantly in a negative direction. This aspect of the strategy is beneficial for QQQY, as the fund is exposed to positive theta. The faster decay of the option’s value works in the fund’s favor, as it allows QQQY to potentially retain the full premium received from selling the options if they expire worthless or are close to their strike price at expiration.
This approach, however, comes with its risks. While the rapid time decay can lead to quick profits from the premiums, it also means that any significant adverse movement in the Nasdaq-100 Index could lead to substantial losses. The fund’s strategy relies on the stability or positive movement of the index, making it vulnerable to sudden market downturns.
Within the last month, QQQY posted a slight decrease in total return of 0.80% (compared to 3.66% return of the QQQ). This performance, in a traditionally volatile period, shows the impact of market movements on QQQY’s unique strategy of selling at-the-money options. Peers within the same category, such as JEPY, CONY, and TLTW, have also experienced slight declines, with total returns ranging from -0.31% to -1.74%. An outlier in this peer group, NVDY, showcased an impressive 3.82% return, illustrating a more robust performance in the short-term frame.
Over a longer 6-month horizon (as the fund as has only been around since September of 2023), QQQY presented a more positive picture, achieving a 4.85% total return, but significantly underperformed QQQ, which posted a return of 10.23%. This period allowed the ETF’s strategy to capitalize on favorable market conditions and the accruing benefits of positive theta from its options strategy. However, this performance is modest when compared to CONY, which surged with an exceptional 61.92% total return, likely benefiting from specific market conditions or strategic positions that significantly outperformed during the period. On the opposite spectrum, TLTW faced a significant downturn with an 8.79% loss, reflecting the diverse outcomes within this group resulting from different market exposures and strategies.
When considering liquidity, QQQY stands with an average daily dollar volume of $11.21M, indicating a healthy level of trading activity and the ability for investors to enter and exit positions with relative ease. The ETF’s assets under management (AUM) total $271.12M, providing a solid foundation for its options-based strategy. In comparison, TLTW leads the liquidity parameters with an impressive average daily dollar volume of $19.38M.
The peer comparison over these time frames demonstrates the varying performance metrics and market resilience of income-generating ETFs like QQQY. While short-term performances have seen declines, the 6-month period paints a more favorable growth trajectory, with QQQY’s strategy showing resilience amidst market fluctuations. This analysis provides investors with a broader perspective on the fund’s standing in the current investment landscape, considering both performance and liquidity.
My view on QQQY is one of cautious observation. The ETF embodies a complex strategy centered around selling at-the-money options on the Nasdaq 100, which, while innovative, does not yet have a long-standing track record to fully assess its long-term viability. The fund’s short-term performance over the past month has not been particularly striking, with a slight decline that underscores the challenges inherent in its active management approach. Over a six-month period, the performance has shown some promise, but it remains to be seen whether these returns can be sustained or improved upon in various market conditions.
Given the ETF’s relatively brief history and the lack of substantial data to back its performance, it is prudent to withhold a buy rating at this juncture. The dividend distributions, as well as the yield, are certainly impressive, but potential investors should consider the fund’s sophisticated strategy, which may not be suitable for all due to its inherent complexities and the elevated level of risk associated with options trading.
I recommend that investors are better served by adopting a ‘wait and see’ approach, monitoring QQQY’s performance as it continues to mature and its market strategy is further tested. It is possible that with time and more data, the ETF could prove to be a valuable component in a diversified portfolio, particularly for those seeking alternative income sources. However, until there is more evidence of consistent performance across various market conditions, a degree of caution is warranted.