After more than a decade of accelerating returns, a combination of high valuations and rising inflation has negatively impacted the growth-heavy NASDAQ-100® Index. At Horizons ETFs, we were very intentional when launching this index exposure with the NASDAQ-100 Covered Call ETF (QQCC) – we believe that this index remains a key benchmark for U.S. equity investing.
While the index itself has seen significant declines year-to-date, approximately -29.64% for the period ending October 31, 2022, there is probably still a higher proportion of investors who remain committed to the index given that its top holdings represent many of the pre-eminent names in global equities, including Microsoft, Apple, Amazon, Alphabet (Google), NVIDIA, Pepsi, and Costco, to name a few. Regardless of a looming U.S. recession or a steep decline expected in earnings, the likelihood of these large mega-cap U.S. companies reaching a level of impairment that would see them disappear or fall further than the broader U.S. market over the next decade seems statistically unlikely (but of course not impossible).
The challenge for growth-focused or NASDAQ-100 investors is timing a recovery. While there may be a consensus that the NASDAQ-100® Index has better days ahead, when that is, is anyone’s guess. This has made a covered call strategy a very compelling way to own the NASDAQ-100 Index since investors can utilize high levels of historical volatility to generate very attractive call premiums which can be used to generate income for a portfolio or as a cushion against declines in the index.
On a relative basis, owning an ETF like QQCC has simply been a way to invest in the NASDAQ-100® Index during this heightened volatility. QQCC is currently a well-positioned covered call ETF offered by Horizons ETFs and underscores where there is value in using a dynamic covered call strategy, which is that they can generate excess returns during periods of high volatility.
High Volatility = Higher Options Premiums
The amount of volatility on the NASDAQ-100® Index has been extraordinary. The implied volatility of the NASDAQ-100® is above 30% going into the last quarter of 2022. As a result, for option writers, the amount of premium that can be generated on one-month call options has increased.
Many of the largest names of the S&P 500® Index are even larger weights on the NASDAQ-100® Index, which means the implied volatility on the NASDAQ-100® Index is even higher. Apart from a short-spike in volatility during the worst of the COVID-19 pandemic, one-month NASDAQ-100® Index at-the-money options are yielding more than at any point in nearly a decade. The chart shows one-month at-the-money option premium levels as an illustration of how implied volatility can lead to much higher premiums. It should be noted that QQCC primarily writes out-of-the-money options, which would also see a similar correlation to implied volatility, but we would anticipate less premium than an at-the-money strategy.
Volatility Outpaces Inflation
In the case of QQCC, approximately 50% of the portfolio is being written on, meaning the ETF is at a minimum of 50%, invested primarily through ownership of the Horizons NASDAQ-100® Index ETF (HXQ). Even on writing on only half the portfolio using primarily one-month out-of-the-money call options, QQCC was able to generate an estimated annualized yield of more than 14% as at the end of October, which far exceeds the yield that would be generated by other income strategies, which have seen their relative yields decline with rising inflation.
This is not the case with call writing. As inflation has created a rise in base-level volatility, it has also created a corresponding increase in call premiums that far exceed the rise in inflation. If volatility remains elevated, we expect QQCC to continue to generate premiums that exceed the corresponding rate of inflation.
QQCC’s strategy of using out-of-the-money call options and only generally write on up to 50% of the total coverage of the portfolio has been very deliberate because we want the ETF to deliver a total return profile that allows investors to get meaningful upside exposure to the price performance of the NASDAQ-100® Index, particularly if/when the index recovers.
Horizons ETFs only changed the mandate to QQCC on June 24, 2022, but since then, the ETF has been one of the best ways to own the NASDAQ-100® Index in the current negative market environment.
Below is QQCC versus a selection of NASDAQ-100® Index strategies in their local-denominated currency and the NASDAQ-100® Index priced in U.S. dollars. QQCC has benefitted from the fact that it has a long exposure to the U.S. dollar as well as the very attractive income it has been able to generate to offset the higher volatility on options premiums.
|Name||Ticker||1 Mo (%)||3 Mo (%)||6 Mo (%)||YTD (%)||1 Yr (%)||3 Yr (%)||5 Yr (%)||10 Yr (%)||SIR (%)||Inception date|
|Horizons NASDAQ-100 Covered Call ETF||QQCC||3.91||-3.58||0.58||-5.74||-4.58||1.37||-0.33||0.70||1.18||2011-08-13|
|Invesco QQQ Trust Series 1||QQQ||3.99||-11.75||-10.94||-29.74||-27.59||12.86||13.61||16.77||8.11||1999-03-10|
|Horizons NASDAQ 100® Index ETF||HXQ.U||3.97||-11.77||-11.03||-29.83||-27.71||12.63||13.27||—||15.67||2016-04-19|
|Horizons NASDAQ 100® Index ETF||HXQ||2.54||-6.14||-5.64||-24.43||-20.42||13.91||14.51||—||16.99||2016-04-19|
|NASDAQ-100 Total Return Index||XNDX||4.01||-11.72||-10.87||-29.64||-27.46||13.07||13.84||17.01||8.57||1999-03-04|
*Since Inception Return. Source: Bloomberg as at October 31, 2022.
The indicated rates of return are the historical annual compounded total returns including changes in per 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. The rates of return shown in the table are not intended to reflect future values of the ETF(s) or future returns on investment in the ETF(s). Only the returns for periods of one year or greater are annualized returns.
The Inception Date shown for Horizons NASDAQ-100® Index ETF (“HXQ” and “HXQ/U”) is the inception date of the predecessor ETF of the same name which was structured as a trust. On November 27, 2019, after receiving unitholder approval, the predecessor ETF merged into a class of shares of a corporate fund structure. In accordance with the exemptive relief, the data of the ETF presented here includes the historical data of the predecessor ETF in order to provide full disclosure of the ETF’s data.
We can show already how additive the call-writing strategy used by the options team is on QQCC. The following charts show the monthly returns, that is the performance between options writing and expiry for QQCC vs. HXQ.U (so the currency isn’t a factor).
QQCC vs. HXQ.U
In the case of QQCC you can see there is meaningful upside capture during a significant rally, as was observed in July of 2022, and meaningful capital preservation during significant selloffs, the ETF is able to offset losses with high levels of harvested options premium.
Source: Bloomberg, as at October 31, 2022
Our view is that QQCC is an effective solution for a “wait-and-see” approach on the NASDAQ-100® Index. QQCC can deliver meaningful exposure to the NASDAQ-100® Index with the added benefit of income that more than supplants income growth needs in an inflationary environment.
Reasons to Consider QQCC
- Direct exposure to some of the largest and most liquid stocks on the NASDAQ-100® Index
- Uses a dynamic call writing approach, which seeks to generate income and reduce downside risk
- Options are written out-of-the-money to preserve more of the upside potential growth of the underlying stocks
- Call premiums are taxed as capital gains
Horizons ETFs Management (Canada) Inc.
Horizons ETFs Management (Canada) Inc. is an innovative financial services company and offers one of the largest suites of exchange traded funds in Canada. The Horizons ETFs product family includes a broadly diversified range of solutions for investors of all experience levels to meet their investment objectives in a variety of market conditions.
The investment objectives of the Horizons NASDAQ-100 Covered Call ETF (“QQCC”) (formerly Horizons Enhanced Income International Equity ETF (“HEJ”)) was changed following receipt of the required unitholder and regulatory approvals. The ETF’s new name and ticker began trading on the TSX on June 27, 2022. For more information, please refer to the disclosure documents of the ETF on www.HorizonsETFs.com.
Effective January 4, 2020, HXQ changed its portfolio from a total-return swap to physical replication of the underlying index. This reduced the expenses applicable to the ETF by the 0.30% swap fee and is expected to increase the trading costs. Overall, the expenses are expected to decline to result in less tracking errors going forward.
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