NVDY: 23% return at the expense of limited exposure to NVIDIA (NYSEARCA:NVDY)

YieldMax NVDA Option Income Strategy ETF (NYSEARCA:NVDY) is one of the classic YieldMax ETFs that seeks to capture some of the risk and return characteristics associated with the very popular and liquid S&P 500 stocks.

in In the case of NVDY, as the ticker name already suggests, its foundation is NVIDIA Corporation (nvidia).

The Fund’s primary investment objective is to achieve high current income through a comprehensive cover call strategy. The second goal is to replicate the performance of NVDA as much as the limitations of the option strategy allow.

Since NVDY applies a synthetic cover call strategy, the key implications (differences from NVDA) in its risk and return profile that do not match those of NVDA must be clearly highlighted.

To do so, let us first understand the mechanics of this particular options strategy.

• First, synthetic long positions are created through intraday traded options. This means that while buying a call option, you are simultaneously selling an NVDA put option with an expiration date of typically 6 to 12 months and a strike very close to the strike price. This is NVDA’s current stock price level. Combining a long call and a short put option creates an exposure very similar to NVDA. So far, there is no bullish or bearish bias towards any particular underlying asset.
• Second, once the synthetic buy is structured, NVDY introduces a covered call aspect where it sells a call option on the underlying NVDA. According to information in the prospectus, these call options typically have an expiration period of up to one month and in most cases have a strike price that is 5% to 15% higher than the strike price at which the synthetic bid was created. As a result of this step, NVDY introduces limits to the potential gains that can be made from underlying exposure to NVDA.
• Third, because all of the aforementioned positions are structured without direct ownership in NVDA, the Fund must hold liquid U.S. Treasury securities as collateral capable of accommodating options transactions.

So, considering the above, the key difference between NVDY and NVDA is that the fund has a built-in cap on the maximum profit that can be earned while receiving additional compensation for this in the form of a sell option premium.

Additionally, there are significant differences in how total returns are achieved. For NVDY, most of its returns are accounted for by dividend income (mostly backed by short option premiums), while for NVDA the main driver is clearly the price appreciation factor.

proposition

Now that I have established how NVDY works, I will detail my thoughts on NVDY as an investment.

Since the inception of NVDY, the fund has performed well, although it has clearly underperformed its underlying assets (i.e. NVDA). In fact, the underperformance (on a total return basis) was quite large, around 30%.

The main reason for this poor performance is the inability to participate in stock price appreciation beyond the prescribed exercise level due to the inherent limitations of capital gains arising from short call options, as mentioned above.

There is a premium on these written calls, but they tend to play a relatively small role when the market is rising (or in this case, when NVDA is rising).

Rather, what’s interesting is that if you look at the moments where results fell off, NVDY actually performed a little bit better due to the premium it pocketed. However, the spread between the NVDY and NVDA charts is clearly very narrow, confirming that covered calls do not play a significant role in the overall equation.

Moreover, the chart above also highlights NVDY’s inherent shortcomings, which are the fund’s tendency to react quietly in situations where rallies are strong or prices surge.

So far, I don’t see any meaningful benefit to owning NVDY. So there may be two instances where it might make sense to take a long position in the fund.

1. In conditions where the market (or in this case NVDA) is trading sideways for a relatively long period of time, the premiums collected will actually matter in the context of limited returns, either slightly negative or positive. In my opinion, this situation of NVDA trading sideways is extremely unlikely, especially considering that it is classified as a pure-play growth stock and is an important part of a major passive stock index that, by definition, injects additional volatility.
2. If a particular investor wants exposure to NVDA and at the same time wants to receive returns in the form of current income. Considering that NVDA yields 0.03%, investors looking for dividends or yield could potentially have trouble here. Therefore, the fact that NVDY currently offers a dividend yield of up to 23% and distributes it on a monthly basis while maintaining some exposure to the NVDA factor may make this fund an optimal solution.

conclusion

NVDY is an interesting vehicle that fits well in the portfolio of investors who believe that NVDA will deliver relatively neutral results or who want exposure to NVDA but are willing to sacrifice some of the potential upside to be rewarded through dividends.

In my humble opinion, it is highly unlikely that NVDA will trade sideways given the level of volatility NVDA has seen historically. Stocks are likely to move in noticeable phases, either upward or downward. In the former case, NVDY will significantly reduce potential profits, while in the latter case, the additional benefit (i.e. protection) from the call premium will be minimal as it already has a proven history of reducing momentum.

The only reasonable justification for holding NVDY would be the dividend aspect. At least in my case it doesn’t really matter. Especially if it means sacrificing profit potential in an inherently volatile and risky position.