For the three-month period from December 1, 2022, to February 28, 2023, the Horizons NASDAQ-100 Covered Call ETF (“QQCC”) outperformed the NASDAQ-100® Index on a total return basis – notable for a covered call strategy during a period with a sizeable rally occurring in its underlying benchmark:
Typically, covered call strategies can be expected to provide meaningful outperformance versus a long-only equity strategy during market declines. However, the opposite tends to be true during market rallies, where a covered-call strategy can miss out on the potential capital appreciation of the stocks in exchange for the income they have harvested by selling calls.
On a year-to-date basis, the NASDAQ-100® Index, as represented by an investable solution, the Horizons NASDAQ-100 Index ETF (“HXQ”) is up 11.01% as at February 28, 2023, whereas QQCC delivered a 9.37% return during that same period.
However, during the month of February, QQCC outperformed HXQ (2.18% vs. 2.13%) and over the last six months ending February 28, 2023, QQCC is up 5.29% vs. 2.23% for HXQ. This relative outperformance during these periods has all occurred since the update of QQCC’s investment objective on June 24, 2022.
Table 1. Standard Performance – February 28, 2023 (% in CAD)
|1m||3m||6m||Update*||YTD||1y||3y||5y||10y||Since Inception||Inception Date|
|Horizons NASDAQ-100 Covered Call ETF (QQCC)||2.18||1.95||5.29||8.40||9.45||-0.51||5.22||1.06||1.16||1.63||09/13/2011|
|Horizons NASDAQ-100® Index ETF (HXQ)||2.13||1.68||2.23||6.61||11.01||-8.46||13.57||13.79||–||17.09||04/19/2016|
|Nasdaq-100® Index Total Return (XNDX)||1.83||0.94||2.51||6.76||10.96||-8.41||13.91||14.34||20.55||8.20||03/04/1999|
Source: Bloomberg, as at February 28, 2023
The indicated ETF rates of return are the historical annual compounded total returns, including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Additionally, index returns do not take into account management, operating or trading expenses that may be incurred in replicating the index. The rates of return above are not indicative of future returns. ETFs are not guaranteed, their values change frequently, and past performance may not be repeated. The indices are not directly investible. Only the returns for periods of one year or greater are annualized returns.
*Effective June 24, 2022, the investment objectives and strategies of the Horizons NASDAQ-100 Covered Call ETF (“QQCC”) (formerly Horizons Enhanced Income International Equity ETF (“HEJ”)), were changed following receipt of the required unitholder and regulatory approvals, to seek to provide exposure to the performance of an index of the largest domestic and international nonfinancial companies listed on the NASDAQ stock market (currently, the NASDAQ-100® Index and to employ a dynamic covered call option writing program. Previously, the ETF sought to provide exposure to an underlying equal-weight equity portfolio and to the writing of covered call options on 100% of portfolio securities. The new ticker began trading on the TSX on June 27, 2022. For more information, please refer to the disclosure documents of the ETFs on www.HorizonsETFs.com.
This level of performance after the objective updates by QQCC relative to its benchmark is in part related to the premiums that are being generated from Horizons ETFs’ NASDAQ-100® option writing efforts.
The NASDAQ-100® is particularly rich for harvesting premiums due to its implied volatility. From a relative and absolute performance perspective, writing calls could be more accretive to generating greater total return compared to holding passive NASDAQ-100® index funds, like HXQ, on their own.
The average annualized implied volatility of the NASDAQ-100® is around 20%, which typically results in annualized monthly at-the-money option premium of 2%. Currently, implied volatility is closer to 30% and generating an implied at-the-money premium of nearly 3%, as at February 28, 2023.
QQCC doesn’t write at-the-money options. Instead, dynamically set options are written on about 50% of the portfolio, which is still generating a yield that is around 13.26% annualized based on the most recent distribution, as at February 28, 2023.
This is a considerable value add for this particular benchmark, since the NASDAQ-100® itself has historically, had a relatively small yield of less than 1%. Call writing changes the dynamics of this benchmark entirely, and effectively can “super-charge” it as an income strategy that can be used to generate levels of yield that are largely non-correlated to traditional fixed income and also currently more than two times the current rate of inflation.
As we can also see in Table 1 performance chart, by preserving the upside potential on up to 50% of the portfolio, QQCC has been able to outperform the underlying NASDAQ-100® Index since the strategy was revamped on June 24, 2022, with its new investment objective.
This example uses the estimated annualized yield of the ETF as at February 28, 2023 and the estimated annualized yield of the ETF’s underlying index benchmark exposure as at February 28, 2023.
Outperformance on a total return basis could be fleeting, and investors should maintain expectations that should the NASDAQ-100® have a strong upside rally from here, they could be giving up some upside total return potential by opting for QQCC versus a NASDAQ-100® Index ETF like HXQ. However, this slippage is probably not as high as it could be, given how rich the premium is on NASDAQ-100® options.
This can make QQCC a powerful “portable yield” strategy – that is, a potentially powerful income replacement alternative to traditional income strategies. As long as an investor expects the NASDAQ-100® to generate positive capital returns over the next one to three years, then it can be a way to potentially generate higher levels of income to meet or exceed their personal portfolio yield targets.
When investors are thinking about income, they are likely not thinking about the NASDAQ-100®, but QQCC is proving it’s worth consideration!
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