FTQI: Covered Call ETF That Falls Short For Similar Reasons Many Do (NASDAQ:FTQI)

by Rob Isbitts.

First Trust Nasdaq BuyWrite Income ETF (NASDAQ:FTQI) is one of a peer group of exchange-traded funds (“ETFs”) that tries to do what many retail investors do on their own, or perhaps through a financial advisor: own a set of stocks and write covered calls on that portfolio, to generate cash flow, while sacrificing some upside. FTQI does a mediocre job of pursuing that objective. I rate it a Sell in part because of issues related to this specific ETF, and in part because I believe covered call writing is highly overrated and will disappoint investors in bear market cycles.

Strategy

Option strategies can be complex, and while I do go into some detail below, I’m going to state FTQI’s strategy by paraphrasing what First Trust, its owner, says in its prospectus:

The Fund’s investment objective is to provide current income. The Fund pursues that by investing equity securities and by utilizing an “option strategy” consisting of writing (selling) U.S. exchange-traded covered call options on the Nasdaq-100 Index, in order to seek additional cash flow in the form of premiums on the options. A premium is the income received by an investor who sells an option contract to another party.

ETF Grades

• Offense/Defense: Offense

• Segment: Tactical

• Sub-Segment: Covered Call.

Technical Ratings

• Short-Term (next 3 months): D

• Long-Term (next 12 months): D.

Rating scale: A = Excellent, B = Good, C = Fair, D = Weak, F = Poor

For a detailed description of MII’s proprietary technical rating system, see disclosures at bottom of this report.

Holding Analysis

First Trust Nasdaq BuyWrite Income ETF holds all of the stocks in the Nasdaq 100 Index, and maintains a covered call position on that same index, such that the “notional value” of the options covers approximately the full portfolio. Notional value refers to the dollar value that the call options represent. It is calculated by multiplying the number of options sold (technically, they are shorted) by 100 (as with most options), and then multiplied by the strike price of the call options. These call options are not bought on the individual stocks in the index, but rather on the Nasdaq 100 Index itself.

Strengths

FTQI and funds like it try to attract investors with high income yields. This one yields about 9.5% as of this writing. That’s the best feature of this ETF. But if income investing were that simple, this fund would have more than $29 Million in it in this, its 10th year of operation.

FTQI has avoided total disaster in Nasdaq 100 crashes, as evidenced by the fact that its maximum drawdown (drop from a peak to a trough in value) is only about 19%.

Weaknesses

However, 19% is still real money. And this is where I think investors are really playing with fire in 2023’s stock market. They see the big yield, they see the Nasdaq, and they paint a picture of an ETF that will get them Nasdaq-like upside, pay them a nice dividend, and cushion declines. Most of those assumptions do not play out in bear markets. Yet investors come running back to covered call ETFs time and time again.

Below is a good recent example of how First Trust Nasdaq BuyWrite Income ETF has limited upside when the Nasdaq 100 roars. The call options are currently struck at around the 12,000 level of the Nasdaq 100. Recently, that index vaulted above that mark, which rendered this fully-covered (by call options) portfolio far less juicy than the index it owns. Covered call writing is a fine strategy, but in automated, indexed, ETF form, it has holes. The interesting thing is, this ETF is not an index fund. There is some manager discretion here. That is helpful, given that the option positions may need to be reset in manic markets.

Opportunities

Granted, since I am negative on most aspects of FTQI, it is a stretch to name an “opportunity” for this ETF in the current market environment. However, there is one scenario that likely a best of all worlds for FTQI and its peers. That is a steady, slow, ascent in the Nasdaq 100 Index. That allows this ETF to grab a good chunk of the upside, while getting paid that handsome dividend. However, expecting the Nasdaq 100 to behave like a turtle walking across the road (slow and steady) is akin to expecting a child to sit still after you have given them 5 bags of candy. That’s not happening. Thus, the scenario above is unlikely.

Threats

As I occasionally say in my ETF profile reports on Seeking Alpha, the biggest threat of this ETF is that investors will own it based on the type of false pretenses noted earlier in this report. As this graph shows, First Trust Nasdaq BuyWrite Income ETF’s long-term record is miserable. I surely do not expect it to keep up with the Nasdaq 100 bull market like the historic one we had. However, it is clear from this picture that the covered call aspect here is taking away much more opportunity than I’d be willing to sacrifice.

Conclusions

ETF Quality Opinion

There is not enough here to make me want to own this ETF, or others like it, without some type of complementary piece (such as pairing it with an ETF that better-protects the downside, and/or one that offers additional upside). But that is beyond the scope of this article.

ETF Investment Opinion

First Trust Nasdaq BuyWrite Income ETF gets a Sell rating from me. After more than 9 years, it is not a case of “it’s just overdue” to perform. The track record and constraining structure is sufficient to cause me to look elsewhere.

Modern Income Investor’s proprietary technical rating system was created by the firm’s founder, Rob Isbitts, a chartist for more than 40 years. The ratings emphasize risk-management, and the belief that while any investment can appreciate in price at any time, each investment carries a different level of potential for major loss. The balance of reward and risk is calculated each night for thousands of securities, using a formula that analyzes price trend, strength of that trend and key price levels. It analyzes data over multiple time frames to produce a short-term rating (looking 3 months out) and a long-term rating (looking 12 months out).