The NEOS Russell 2000 High Income ETF (IWMI) is a buy-write strategy designed to provide investors equity exposure to the Russell 2000 while overlaying a call options strategy to earn income for the portfolio. With a 13.66% yield, IWMI can be utilized by investors seeking current income in place of capital growth as part of an income-oriented investment strategy.
About NEOS Russell 2000 High Income ETF
IWMI was launched by NEOS ETF Trust on June 24, 2024, on the CBOE BZX Exchange. IWMI has a competitive expense ratio of 76 bps, 68 bps of which derives from the management fee.
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IWMI pays out a monthly distribution largely derived from the performance of the options strategy. The ETF has paid out $7.03/share over the last twelve months for a yield of 13.66%. The distribution can vary from month to month, though the fund has generally remained in a relatively narrow range since inception. In general, the majority of the distribution will derive from return of capital, returning investors’ principal investment over time. The result of this will lower the investor’s cost basis as a tax-deferred benefit until the cost basis reaches $0/share, at which point excess ROC will be taxed as short-term capital gains or ordinary income. While this type of strategy may not be suitable for investors seeking long-term growth through index investing, the strategy can be used by those seeking current income, effectively facilitating retirement distributions without the need to sell shares.
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One result of ROC will be NAV erosion over time, which will be present when comparing the price return of the Russell 2000 Index and IWMI. When comparing the performance of the fund, investors should view IWMI on a total return basis to evaluate the relative performance of the fund to the Index.
IWMI has two components that make up the portfolio:
Equity investments.
Options investments.
The equity component of the portfolio consists entirely of the Vanguard Russell 2000 ETF (VTWO). From an investment perspective, exposure to VTWO will provide investors with equity growth with respect to the Russell 2000 Index.
The options strategy utilizes Section 1256 Russell 2000 (RUT) index options contracts to gain short exposure to the Index. These contracts exhibit a special tax benefit with a 60/40 split between long- and short-term capital gains, potentially lowering the entirety of the tax burden on investors. The fund will effectively write covered call options on the underlying Index to earn income for investors.
The options trading strategy comes with some caveats that may limit the full upside potential of the equity component of the fund. Given that the fund writes call options on the Index, the fund will limit its upside potential to the strike price of these short option positions. If the Index were to exceed the strike price, the fund may lose money making up the difference between the strike price and the price of the Index at the time the options are rolled forward. In order to protect the fund from significant losses, IWMI may trade call spreads in order to limit the full downside risk. This means that the fund will purchase call options with a higher strike price with respect to the written options, limiting the exposure to risk. The call spreads will essentially create an opportunity for IWMI to limit the downside potential of the short options positions with respect to the strike price of the long call options, limiting losses to the spread between options and the premium paid for the protection.
Investor Suitability
IWMI can be best utilized by income-oriented investors seeking current income while investing in an equity-linked portfolio strategy. Investing in IWMI will provide both equity upside potential along with options premium income over time. The benefit of utilizing IWMI over a standard Index fund is that monthly income can be pulled without having to sell shares of the fund. IWMI can be utilized as an alternative strategy for fixed income or as an equity component as part of a diversified portfolio strategy. Investors will be issued a Form 1099-DIV at the end of the calendar year for tax reporting purposes.
Risks Related To IWMI
IWMI is a buy-write strategy designed to provide equity and options income exposure to the Russell 2000 Index, creating certain risks that should be considered prior to making a final investment decision. IWMI may limit the full upside potential with respect to the underlying Index as a result of the covered call strategy. The fund may also face losses during periods of significant Index growth, which would result in IWMI experiencing a potential loss on the short options positions. The options positions are actively traded by the portfolio management team, exposing investors to manager risk and their ability to effectively purchase and sell call options.
Final Thoughts
IWMI can be utilized by income-focused investors seeking to gain equity exposure using the Russell 2000 Index. The fund’s distributions can benefit income investors by returning invested capital over time, reducing the need to sell shares for portfolio distributions.
This article answers three main questions about IWMI:
- What type of investor is IWMI best suited for?
- What are the benefits and risks of investing in IWMI?
- Does IWMI have any tax advantages for investors?
Editor’s note: This article is intended to provide a general overview of the ETF for educational purposes only and, unlike other articles on Seeking Alpha, does not offer an investment opinion about the ETF.
