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The Truth About the $QYLD ETF's 12% Yield (Monthly Dividend) - YouTube
Channel: Tyler McMurray
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Iâve been receiving a handful of comments
asking about the QYLD ETF, so I figured it
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was about time I covered it and took a closer
look at the strategy.
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QYLD is the Nasdaq 100 Covered Call ETF, and
with a dividend yield of approximately 12%
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paid monthly, it attracts a ton of dividend
and income investors.
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Given that itâs a yield-focused investment,
I tend to read the ticker as âq-yieldâ,
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so thatâs what Iâll be calling it throughout
this video.
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But in this video, I want to investigate the
QYLD strategy to understand how it can offer
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such a sizable yield every month.
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To do this, weâll be diving into the QYLD
portfolio and what its covered call strategy
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looks like.
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Covered calls are a common options trading
strategy, and understanding that strategy
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is key to understanding this ETF.
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After breaking down the strategy, weâll
take a closer look at the potential returns
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of QYLD, and when it makes sense to have this
fund in your portfolio.
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Weâll also take a look at the tax ramifications
of this ETF, which is always important to
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consider when dividends are involved.
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Last, if you like the sound of the Nasdaq
100 covered call strategy, weâll consider
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a few alternatives that give investors more
control over their returns.
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So letâs take a look.
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As the name suggests, the QYLD ETF invests
in the Nasdaq 100 index, then uses a covered
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call strategy to generate income off of those
holdings, generating dividends for investors.
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Weâll break down both of these components.
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The Nasdaq 100 index is a market-cap weighted
index of the 100 largest stocks that trade
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on the Nasdaq, excluding REITs or financial
stocks.
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The Nasdaq 100 claims to be an innovation-focused
growth index, which as I discussed in my video
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comparing it to the Ark ETFs, isnât completely
accurate.
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Based on the Nasdaqâs history as a technology-driven
exchange, it has naturally attracted more
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tech companies than something like the New
York Stock Exchange.
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This is why the Nasdaq 100 has outperformed
the S&P500 in recent years, because it is
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heavier into these tech-focused companies
that could be loosely considered innovators.
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I think theyâre trying to use innovation
as a buzzword to compete with Ark Invest funds,
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but thatâs just my two cents on the subject.
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Anyway, there are a few ways to invest into
the Nasdaq 100 index.
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Most common is QQQ, an Invesco ETF that tracks
the Nasdaq 100 by investing into all 100 of
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its stocks as they are represented in the
index.
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Similarly, QYLD purchases each individual
stock as represented in the Nasdaq 100 index.
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So this means it will be nearly identical
to the QQQ portfolio and the Nasdaq 100 index.
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So as we would expect, the QYLD portfolio
matches the Nasdaq 100 index almost perfectly.
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And this means that as an investor into QYLD,
you get âlongâ exposure to the Nasdaq
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100 index, just like you would by investing
into QQQ or a similar ETF.
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However, as the Nasdaq 100 is largely made
up of growth companies that pay little or
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no dividends, this may not be ideal for an
income or dividend-focused investor.
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And thatâs where the covered call strategy
comes in.
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Covered calls are an options trading strategy
that can be used to generate additional income
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from stocks, whether or not they pay a dividend.
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To use covered calls, you have to own the
underlying stocks.
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So this is something the QYLD ETF is able
to do on its portfolio because it owns all
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of the stocks in the Nasdaq 100 index.
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As an individual, you have to own 100 shares
of a stock or ETF to perform the covered call
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strategy.
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Then, you can sell or âwriteâ a covered
call, which means you create a contract that
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gives someone else the right to buy your 100
shares at a certain price.
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Someone pays you for this contract, which
helps you earn extra cash on the stock.
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The catch is, if the price of the stock moves
up, the other person can execute that contract
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and force you to sell your shares to them
at the agreed upon price.
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Iâll give you a quick example with Apple
stock.
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So letâs say I owned 100 shares of Apple,
and I want to make more income from these
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shares than its measly dividend.
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Since I own 100 shares, I can sell a covered
call.
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You can see on this option chain that Apple
is trading around $134.
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I can sell a covered call with a strike price
of $140 and earn $4.38 per share, otherwise
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known as the premium.
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Since each covered call contract is for 100
shares, this would be an instant $438 for
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creating the contract.
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Once sold, the buyer has until the expiration
date, in this case June 18th, to execute our
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contract, and can only do so if the price
of Apple stock is at least $140.
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If they choose to execute the contract, I
would be forced to sell my 100 shares to them
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for exactly $140.
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However, if the stock doesnât reach that
price by the expiration date, I get to keep
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my shares and all of the money I collected
in premium.
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So as you can see, if you donât expect the
stock price to increase beyond a certain price,
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a covered call lets you earn some nice income
on your shares.
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However, it also limits your potential returns,
because if a stock shoots up, youâre forced
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to sell your shares at the set strike price,
no matter what price the stock ends up reaching.
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But in a nutshell, this is the strategy that
QYLD uses on its holdings to generate high
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dividends for investors.
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The only difference is, instead of selling
covered calls on individual stocks in its
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portfolio, it sells a covered call on the
entire Nasdaq 100 index, essentially tying
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up its entire portfolio in a single options
strategy.
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Letâs take a closer look here.
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The QYLD ETF writes their covered call contracts
on a monthly basis, with each contract expiring
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the following month.
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When they do this, they select the closest
available strike price above the current price
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of the Nasdaq 100 Index.
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This is known as an at-the-money option, because
the price needs to move very little for the
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buyer to execute the contract.
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This is different from the Apple example I
showed you earlier, because the $140 strike
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price was farther away from the current stock
price of $134.
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So in the case of the QYLD portfolio, theyâre
almost guaranteeing that they wonât earn
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a large positive return on their portfolio,
because the contracts will likely be executed
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if the index above that strike price.
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However, the interesting thing about these
covered calls on the Nasdaq 100 index is that
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they canât be executed early, unlike regular
call options which can be executed at any
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point before the expiration date.
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So the contract only gets executed if it expires
with the Nasdaq 100 index at or above the
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strike price.
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And this means QYLD covered call strategy
has some very specific implications for investors.
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First of all, youâre not expecting the ETF
to produce returns via price growth.
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The price of the ETF will fluctuate a little
bit based on the performance of the individual
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stocks in the Nasdaq 100 index, but only to
a certain point.
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Youâre expecting to receive most or all
of your returns from the premiums collected
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from the covered call contracts.
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And this is why the price of the ETF has been
more or less the same since inception, bouncing
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between $20 and $25.
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It caps its own growth potential in favor
of collecting cash premiums and distributing
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them to investors every month.
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In comparison, you can see that the Nasdaq
100 index as measured by the QQQ ETF has produced
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huge price appreciation over the last several
years, while only offering about a half percent
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dividend yield.
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This particular chart makes QYLD look pretty
bad - but when you consider the total returns,
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which includes dividends, itâs historically
produced around 9% returns a year before taxes.
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Another important thing to understand about
the QYLD ETF is the impact of market volatility.
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First, because the covered call contracts
cannot be executed until the end of the month,
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market volatility doesnât really matter
until the last day of the month.
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The NAV may fluctuate throughout the month,
but the main concern for investors should
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be whether the price of the Nasdaq 100 index
falls above or below the strike price of the
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contract written at the beginning of the month.
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Volatility does play a role in the value of
options contracts, because premiums will be
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higher in a volatile market.
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And thatâs something weâll consider more
in a minute, because QYLD will produce higher
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dividends in higher volatility, which is exactly
weâve seen recently.
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But volatility aside, there are 3 potential
outcomes for QYLD in a given month, which
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will tell us which kind of markets we might
want to hold this ETF in.
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First is that the market goes down, and the
month ends with the Nasdaq 100 index priced
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below the strike price of the contract.
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In this case, QYLD gets to keep their options
premium and their stocks.
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While the NAV of the fund would drop in this
case, these losses would be offset by the
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dividends that investors receive.
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So in a bear market, QYLD can be a hedge against
downward price action to limit your losses
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and continue receiving dividends.
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Second is that the market stays flat, with
the index priced at or near the strike price
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of the contract at the end of the month.
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In this case, QYLD gets their options premium
and the contract would likely not be executed,
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so the holdings of the fund will remain the
same.
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This is the optimal outcome for investors,
because the NAV remains the same but you still
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get to collect the dividends.
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The last outcome is if the market goes up.
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In this case, QYLD still gets that option
premium, but theyâll likely have to liquidate
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their holdings to satisfy the contract when
it gets executed.
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This will have a small increase in fund NAV,
but as we mentioned, it will be limited because
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the holdings have to be sold at the strike
price.
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So if the Nasdaq index moves far above the
strike price, investors are missing out on
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any additional returns.
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Considering these three outcomes, we can speculate
as to when the best times to hold the QYLD
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ETF would be.
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As we said, it can be a good hedge in bear
markets when downward price movements can
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be expected.
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In these cases, you can still earn some returns
through dividends that can cancel out or mitigate
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a loss in portfolio value.
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We can see that QYLD has performed better
than the Nasdaq 100 in these environments.
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The best time to hold this kind of investment
seems to be a flat market or a highly volatile
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market.
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In a flat market, the Nasdaq 100 index would
not be producing returns, making QYLD a great
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way to earn returns through dividends when
the underlying assets arenât moving.
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Similarly, since options premiums increase
with market volatility, this strategy would
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be more profitable in a volatile market.
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But, if the volatility skews towards the upside,
you may want to reconsider.
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This is because in a bull market, youâre
limiting your potential returns with the covered
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call strategy.
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Youâll still receive dividends, but your
total returns would be far greater if you
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just held the QQQ ETF or a similar investment.
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One last key thing to consider about QYLD
is the tax implications as a dividend-focused
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investment, because the cost of taxes can
quickly eat into the returns of this ETF.
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Ordinarily, gains from covered call options
in this strategy would be taxed at 60% long-term
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capital gains tax rate and 40% short-term
capital gains tax rate.
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Depending on your particular tax bracket,
you may choose to hold this in a tax-advantaged
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retirement account to reduce the impact of
those taxes on your returns.
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However, QYLD has been doing something pretty
interesting with their recent distributions.
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Throughout 2020 and so far into 2021, their
distributions have been 100% return of capital.
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A return of capital means theyâre returning
a portion of your initial investment back
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to you, which is not immediately taxable.
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When you receive a return of capital, you
donât pay any taxes on it, but it reduces
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your cost basis in your investment.
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So eventually, if you sell your QYLD shares
after receiving one of these distributions,
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youâll pay capital gains taxes on an amount
equal to the difference in the current share
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price, and your initial purchase price minus
any dividends youâve received.
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This is considered tax-deferred, because you
donât have to pay any taxes until you sell
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your shares.
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You just have to be careful here, because
the tax hit can be pretty heavy if youâve
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held for a long time and youâre not expecting
it.
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But this is a clever strategy that QYLD uses
to give investors more control on when they
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realize their tax obligation.
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Theyâre able to use any capital losses they
receive throughout the year to offset the
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gains from options premiums.
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Then, they choose to give you âreturn of
capitalâ instead of the money theyâve
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earned through premiums.
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So currently, you could be holding QYLD in
a standard investment account with no immediate
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tax obligation, which is great for the short
term.
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You just have to be aware that you will eventually
owe taxes on these dividends when you decide
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to sell your shares.
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And thatâs just about everything you need
to consider about the QYLD ETF.
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However, I wanted to quickly point out two
alternative strategies you may also want to
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look into.
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First is performing the covered call strategy
on your own with the QQQ ETF.
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To do this, youâll need to own 100 shares
of QQQ, which is about a $34,000 investment.
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But if you can pull this off, youâll have
much greater control by selecting the covered
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call contracts you create.
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Then you can choose strike prices that give
you more room for upside growth or you can
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choose different time frames to customize
the strategy.
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Additionally, youâll only be paying the
.2% expense ratio of QQQ, instead of the .6%
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expense ratio of QYLD.
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The second alternative is the new QYLG ETF.
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This is the perfect blend of QQQ and QYLD.
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In contrast to QYLD, which writes covered
calls on 100% of the portfolio, QYLG only
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writes covered calls on 50% of the portfolio,
and still has all of the same stocks as the
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Nasdaq 100 index or QQQ.
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So with this strategy, youâre getting more
upside potential than QYLD, but also getting
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a larger dividend than with QQQ.
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Since the high yield and covered call strategy
of QYLD is a superior choice to QQQ in flat
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or bear markets, QYLG, which gives its portfolio
more potential upside, might fit well into
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a portfolio during a volatile market or a
flat market that has some potential for gradual
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upside price action.
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Long-term, weâd probably expect to see the
yield from QYLG fall somewhere between QQQ
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and QYLD, likely in the range of 5 to 6%.
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But thatâs all Iâve got for you guys on
QYLD and its covered call strategy.
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Leave me a comment and let me know how youâre
using this fund in your portfolio, if at all.
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As always I appreciate your support and Iâll
see you in the next video.
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