US Global X Covered Call ETFs RYLD and XYLD: Is it Worth to buy?

Share:
Photo by Joshua Mayo on Unsplash

As an income investor, I am always on the lookout for good and sustainable dividend stocks or ETFs (exchange traded funds). Recently, I discovered 2 US ETFs which utilize options writing to generate income for their portfolio of stocks. They are the Russell 2000 Covered Call ETF (RYLD) and S&P 500 Covered Call ETF (XYLD). As of time of writing, RYLD has an ETF price of US$20.94 and a 12-mth trailing dividend yield of 14.95% while XYLD has an ETF price of US$45.13 and a 12-mth trailing dividend yield of 11.47%. With such mouth-watering yields, it is very tempting to allocate some of your capital to these counters for exposure. Before we discuss the advantages and disadvantages of owning these ETFs, let us get acquainted with the terms of options.

What are covered calls exactly?

In finance, a call option gives the buyer the right but not obligation to buy shares at a certain price known as the strike price. The buyer of the call option pays a sum of money, known as the premium, to the seller of this contract. The buyer is said to be bullish on the stock or ETF because he would exercise the right when the share price rises significantly above the strike price. Conversely, if you sell (or write) a call option, you are paid a premium to exercise your shares at an agreed strike price should the share price shoot up beyond the strike price. If you own the shares that you write call options to, you are essentially executing a covered call position. You are hoping that the share price will be fluctuating sideways or even decline a little as you would want the option to expire worthless ideally.

Now, is RYLD and/or XYLD a good buy as of now? I list some of the pros and cons of these ETFs that I have researched on the Internet:

Pros:

  1. Above average dividend yield

The first obvious benefit to owning these ETFs is the high income yield you will get to enjoy. RYLD has a yield of 14.95% as of today while XYLD has a 11.47% yield. In contrast, the S&P 500 ETF SPY only has a dividend yield of 1.43%. The fruits of compounding may work in your favor if you buy these ETFs at regular intervals (aka “dollar cost averaging”).

2. Monthly Payments, compared to Quarterly or Semi-Annual Payments

If you are a retiree, you will like to see your portfolio generate income for you, ideally on a monthly basis. For example, XYLD has made monthly payments for 8 years running while RYLD has made monthly payments for 3 years running.

Cons:

  1. Upside is capped while there is no downside protection

As the fund manager of these 2 ETFs write at-the-money call options to generate the most income, the funds will not appreciate in value as fast as the original index. If you are a growth investor, these ETFs may not suit your investment goals. In addition, the ETFs do not buy a put option to protect its shares from deep declines in price. A put option gives the buyer the right but not the obligation to sell his shares at an agreed strike price. If you want to establish a wide margin of safety, you can choose to buy these ETFs after a major market sell-off. It is of no guarantee that you will not experience unrealized losses but it will likely be lesser than somebody who bought their ETF shares at the peak. For the RYLD ETF, some investors are wary of its resilience to market crashes as it is a relatively new counter debuting in 2019. In exchange of less yield, one can buy XYLD when the market bottoms out from its sell-off for people with less risk tolerance for unrealized losses.

My Personal Take

Personally, I would wait for a market sell-off (at of time of writing: looks like it’s happening now…) till it bottoms out before buying some RYLD shares. Even though I am a foreigner who incurs 30% dividend withholding tax should I buy and receive monthly dividends, 14.95% x 70% = 10.465% is really an above average yield that is hard to find in my local stock market. As I will be buying at a low price, my margin of safety is relatively high. As such, I am comfortable holding these shares for the long term should I get it at a reasonably low price.

Disclaimer:

I can’t decide for you if you should buy RYLD or XYLD because I don’t know your personal financial situation or risk tolerance or investment horizon. I am not a financial advisor, stock broker or investment manager. The above mentioned paragraph is my personal opinion of my investment plan and is not an offer to buy or sell any securities on anyone’s behalf. I will not be liable for any loss through the use of this article’s information as this article is meant to be informational or educational in nature. When in doubt, speak to a registered financial advisor, stock broker or accountant.