High-flying Magnificent Seven stocks have delivered fantastic performance for their investors, but with only a few of the Mag 7 stock paying (small) dividends, they haven't been the best fit for income investors.
ETF provider YieldMax has a solution, offering a series of stock-specific ETFs that use options strategies to generate income from some of the market's most popular stocks. And the income is simply incredible, especially when it comes to the Nvidia(NASDAQ: NVDA) and Tesla(NASDAQ: TSLA) versions.
As of this writing, the YieldMax NVDA Option Income Strategy ETF(NYSEMKT: NVDY) and the YieldMax TSLA Option Income Strategy ETF(NYSEMKT: TSLY) have dividend yields of 84% and 77%, respectively. That isn't a typo.
However, there's no such thing as a safe dividend yield of more than 70%, so it's important to know exactly what you're getting into before investing.
How these ETFs work
As their names suggest, YieldMax Option Income Strategy ETFs use options to generate income.
One key point to keep in mind is that these ETFs don't own any shares of the underlying stock directly. They pool investors' money and buy Treasury securities, which are then used as collateral to create options spreads.
I don't want this to turn into too much of a lesson on options, but there are two general approaches the funds' managers can take. The first, which YieldMax refers to as the "standard strategy" involves selling call options on the underlying stock to generate income, as well as simultaneously selling put options. The "opportunistic strategy" involves selling an at-the-money call option and buying an out-of-the-money call option to allow investors to retain some of the upside potential if a stock moves higher.
In a nutshell, these strategies are designed to mainly generate income, with some upside in share price (fund NAV) is the stock performs in a certain way. There are three scenarios, and they are generally the same as if you use covered calls in your portfolio:
- The stock price rises, but slowly, over time. This is the best-case scenario and is the one that will typically result in the ETF's share price rising over time. The call options sold expire worthless, investors get to keep the option premium, and the fund's managers can repeat the process.
- If the stock declines or is flat, the fund will likely lose value but will outperform simply owning the underlying security.
- The underlying stock performs very well. In this case, the ETF's gains would be limited by the strike prices of its options positions, and the ETF's share price would underperform.
Here's what this all means. The income these strategies generate can be fantastic, but the share price of both ETFs is likely to gradually decline over time. In fact, over the past year, Nvidia stock is up by 168%, while the YieldMax NVDA Option Income Strategy ETF is up by just 5%. Of course, that 84% yield helped to level the playing field, but it still didn't perform as well as if you had simply bought the stock.
Tesla is a different story. The stock declined by 17% over the past year, and the YieldMax TSLA Option Income Strategy ETF declined by 55%. Even including dividends, the ETF delivered a negative 18% total return over the past year, roughly matching the performance of the underlying stock.
The bottom line
The YieldMax ETFs are best suited for cases where you think a stock will rise gradually, and with fairly low volatility, over time. Nvidia is a case where a stock performed very well and Tesla is a case where a stock performed poorly, and both YieldMax ETFs underperformed the stocks themselves. If you're considering an investment in these, I'd caution you to limit your position size, and to consider turning off automatic dividend reinvestment, since over time the share prices of both ETFs are highly likely to decline in value.
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Matt Frankel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia and Tesla. The Motley Fool has a disclosure policy.
