Both QYLD and XYLD focus on large-cap stocks due to the nature of their underlying indexes. For an income-focused approach to small-cap investing, investors can pick RYLD, which uses the Russell 2000 index as its underlying asset. Thanks to the higher volatility of small-cap stocks, RYLD currently sports a 12-month trailing yield of 14.3% against the usual 0.6% expense ratio. That being said, RYLD may not be for everyone.
“Writing call options on high-volatility indexes may cap your upside potential if the index runs up but still expose you to significant downside volatility if the index turns south,” says Mark Andraos, associate portfolio manager at Regency Wealth Management.
By selling covered calls, investors also run the risk of capping the higher upside potential that small-cap stocks can potentially deliver.
“There is a common misconception that covered call ETFs are hedged strategies,” Andraos says. “They are not ‘hedged’ in the traditional sense, as you are still subject to the same downside market risk as the underlying equities or index the ETF owns, with your losses cushioned slightly by the income generated by the options premium.” For a hedged alternative, investors can consider NUSI.
This ETF starts by selling Nasdaq 100 index call options, much like QYLD does. However, NUSI also uses a portion of the premium received to purchase out-of-the-money, or OTM, put options on the Nasdaq 100 index. This results in a “collar” strategy, where both upside potential and downside risk are limited. The remainder of the premium is paid to investors in the form of an 8.1% trailing 12-month yield.