When it comes to investing, there is no shortage of investment vehicles. There seems to be an ETF that covers any investment thesis, sector, and strategy. There are many ways to meet this objective when it comes to income investing. Investors can allocate capital to individual equities, take advantage of the risk-free rate of return due to the high-yield environment, invest in closed-end funds that focus on private credit and corporate debt, invest in business development corporations or REITs, and invest in ETFs that focus on specific indexes or option strategies to name a few. There is a wide range of investments available to the investment community. While I am a hybrid investor, as I have a portion of my portfolio positioned toward capital appreciation and another to income generation, I still utilize a covered call strategy to generate income from positions such as Tesla (TSLA) and Palantir (PLTR). I even write covered call contracts on REITs such as Omega Healthcare (OHI) and SL Green Realty (SLG). I look at owning shares in a company similar to owning a rental property. Regardless of if the position pays a dividend, I want to write a contract against my shares to generate income the same way a landlord would want a tenant in their property paying them rent. The Neos S&P 500(R) High Income ETF (BATS:SPYI) is becoming one of my preferred income-generating vehicles because the management team invests in the companies I want to own and utilizes an interesting call option strategy that doesn't cap the entire upside of the underlying portfolio. While SPYI is relatively new, it's amassed $1.49 billion in assets under management (AUM) and produced a track record of paying double-digit yields over the trailing twelve months (TTM).
Following up on my previous article about SPYI
Back in March, I wrote an article on SPYI (can be read here) where I discussed how it was turning out to be a sustainable income-generating investment producing a double-digit yield. Since then, shares of SPYI have appreciated by 1.34% and generated an additional 2.06% in monthly dividends, bringing its total return to 3.4%. While this trails the S&P 500, climbing 5.46%, SPYI is focused on generating income with some capital appreciation when the markets go higher rather than focusing solely on capital appreciation. I am following up with a new article because I want to look at how SPYI is fairing compared to similar ETFs that generate yields that exceed 8% and discuss why I am bullish on SPYI going forward.
Risks to investing in SPYI
SPYI is basically an alternative version of an S&P 500 index fund. There are 2 main risks to the investment thesis. The first is that the market enters into a correction, causing a downward trend or macroeconomic conditions to change and cause the market to enter bear territory. SPYI will follow the S&P 500 lower, just as it has in the past. There is no downside protection except for the monthly income being generated, so SPYI will follow wherever the market goes. The second main risk is opportunity cost. Unless you're specifically looking to generate continuous income, SPYI isn't going to be an interesting investment. SPYI utilizes a specific covered call strategy that caps appreciation to some degree, so it will never match the appreciation of an S&P 500 index fund even though it's invested in the same companies.
A quick overview of how SPYI's investment strategy works to generate income
Investors continue to gravitate toward SPYI as its strategy is working. Since my article in September of 2023, SPYI has increased its AUM from $314.37 million to $1.49 billion. In less than a year, SPYI has increased its AUM by 373.96%. When someone sells a covered call against their shares, they are selling the right for somebody else to purchase their shares at a specific price on a specific date. The buyer of the covered call pays the seller a premium upfront. If the share price never gets to the specific price on the expiration date of the contract, then the contract expires worthless. The seller keeps the premium and their shares. If the share price exceeds the specified contract price on the expiration date, then the seller keeps the premium and is paid the specified price for their shares no matter how far over the specified price they are.
In a traditional covered call, the upside is restricted to the strike price, as all gains that exceed the strike price benefit the buyer of the covered call contract. What SPYI has done is create an ETF that doesn't entirely cap the upside potential when the market rises. Traditional covered call strategies will just sell a covered call to generate income. NEOS constructed an ETF where they invest in the companies within the S&P 500 and implement a 2 phase approach to generate income and still participate in appreciating markets. In the first phase, SPYI generates a premium from selling covered calls against its portfolio. This is similar to other funds or an individual who is writing covered calls on their positions. What the team at NEOS did with SPYI that is different is they aren't paying out the entire premium generated. They are taking a portion of the premium they collect from selling the covered calls and turning around and buying call options that are further out of the money than the ones they are selling. Since these calls are less expensive, they are using some of the premiums generated to fund the transaction, while paying the remaining income out through their monthly distribution.
SPYI has paid 21 consecutive distributions since it went public, and the fluctuation in its distribution is minimal. SPYI has been able to generate relatively stable income and, over the past year, has paid out $5.88 in distributions per share, which is a yield of 11.63% based on the current share price. SPYI has returned 1.79% in share price appreciation over the past year and has been up since its inception. Its strategy is an interesting take on the covered call income strategy, and investors are certainly buying up shares based on its results. I like SPYI's take on the concept because the fund remains uncapped to a degree, and while it's mitigating downside risk during a correction, SPYI is allowing investors to participate in some upside while generating large amounts of monthly recurring income.
Comparing SPYI to JEPI and XYLD
I think that SPYI is gaining so much attention, and the AUM continues to increase because it’s outperforming the Global X S&P 500 Covered Call ETF (XYLD) and the JPMorgan Equity Premium Income ETF (JEPI). These are similar funds as XYLD generates income by writing covered calls against its holdings, which are invested across the positions within the S&P 500, and JEPI generates income by creating a portfolio of holdings they feel has a lower volatility level than the S&P 500 with 80% of their portfolio then invests the remaining 20% in equity-linked notes where they run their option overlay strategy. Many of JEPI's holdings, such as Microsoft (MSFT), Amazon (AMZN), Meta Platform's (META), and Alphabet (GOOGL), are the largest components in the S&P 500. JEPI has $33.59 billion in AUM, while XYLD has $2.9 billion in AUM.
Over the past year, JEPI has appreciated by 3.54% compared to SPYI, increasing 1.79%, and XYLD gaining 0.12%. All 3 funds have increased in value, but they are clearly not set up for capital appreciation and geared toward income, as the S&P 500 is up 25.17% over the past year. These are income-focused investments and SPYI's strategy is producing more yield than JEPI and XYLD. Based on the share prices from 1 year ago, SPYI has generated 11.84% in distributions while XYLD generated the 2nd largest yield at 9.45%, and JEPI came in 3rd with a yield of 7.6%. SPYI has the largest yield of these ETFs, and when the dividend yield on cost is combined with the appreciation over the past year, SPYI has the largest total return at 13.63%. JEPI has a total return of 11.14%, while XYLD trailed in the high single-digits at 9.57%. Outside of strictly appreciation, SPYI has a larger yield on cost, yield over the TTM, and total return compared to JEPI and XYLD. I have been a fan of SPYI for some time, and I think these results are making more investors interested in SPYI as an income-generating asset.
Conclusion
It doesn't matter if you have never written a covered call or if you actively engage in the covered call overlay strategy, SPYI provides a unique approach to capitalize on this methodology. After the expense ratio of 0.68%, SPYI still has a double-digit yield, and there isn't much fluctuation in the income it's producing. I think that SPYI will continue to gain traction in the investment community, and its AUM will continue to increase. The reason I am getting more bullish on SPYI is because it invests in the S&P 500, which I believe will continue higher into 2025 and be higher several years down the road compared to where it is today. SPYI allows me to be invested in an asset group I believe will appreciate while generating double-digit income that I can reinvest to benefit from the powers of compounding monthly to increase the amount of income I am generating. This is an investment I can benefit from, with a management team doing all of the work to generate reoccurring income while I focus on other investments I am making. If you're interested in generating income, I think the team at NEOS is managing some strong funds that are worth taking a closer look at.