A few months ago, I wrote an initial review of the Neos S&P 500 High Income ETF (BATS:SPYI), noting that since the fund’s launch in 2022, the SPYI ETF had outperformed other ‘BuyWrite’ strategies involving the S&P 500 Index. Although SPYI’s short track record was impressive, it was unclear how SPYI was able to achieve its outperformance, and I suggested investors should await more data or clarity about SPYI’s strategy.
However, since the markets bottomed in its latest correction phase in late October, the SPYI ETF’s returns have been more pedestrian, with an 8.1% return, essentially inline with the JPMorgan Equity Premium Income ETF (JEPI) and lagging the S&P 500 Index, as represented by the SPDR S&P 500 ETF Trust (Figure 1).
In fact, if we break SPYI’s performance record into different time periods, inception to December 31, 2022, H1/2023 and H2/2023, SPYI’s relative outperformance record has been quite volatile. The SPYI ETF performed poorly from inception to December 31, 2022, returning -2.4% compared to -3.1% for SPY and 3.1% for JEPI (Figure 2).
However, SPYI performed very well in H1/2023, returning 14.5% compared to 16.8% for SPY and 5.5% for JEPI (Figure 3).
But it has been more pedestrian in H2 2023, returning 3.1% vs. 8.0% for SPY and 4.1% for JEPI (Figure 4).
As a reminder, the SPYI ETF claims to have a proprietary ‘data driven’ call option strategy that involves a mix of written call options and long call options, although generally, the fund aims to generate net premium income.
The challenge for investors is that, a priori, it may be difficult to determine whether SPYI will be Dr. Jekyll or Mr. Hyde.
Change In Strategy Could Be Cause Of Recent Pedestrian Performance
As pointed out by a fellow Seeking Alpha analyst, SPYI has recently changed its strategy from writing covered call spreads to writing covered calls. This change in strategy could be the reason why SPYI’s performance has been more pedestrian in recent months.
In a typical Covered Call strategy, the investor owns the underlying stock and writes call options against it. By writing call options against their holdings, the investor forfeits gains above the strike price (Figure 5).
This trade-off of upside vs. premium income is one of the main reasons why Covered Call strategies tend to underperform over the long-run.
However, SPYI’s differentiation, when it first launched, was to write call-spreads instead of calls. In SPYI’s Covered Call Spread strategy, SPYI writes a call with a lower strike price while owning calls at a higher strike price.
By owning calls at a higher strike price, the Covered Call Spread strategy is able to participate in strong rallies in the underlying. The trade-off of this strategy is lower premium income, since part of the premiums received from selling calls must be spent to buy higher strike calls (Figure 6).
The Covered Call Spread strategy came in handy for SPYI in H1 2023, as markets rallied sharply from bear market levels and SPYI was able to participate in more of the market upside compared to other Covered Call funds.
However, in recent months, SPYI’s option portfolio has changed to only consist of written calls, which means SPYI is operating just like other Covered Call strategies (Figure 7). That is why SPYI has been performing more or less like the JEPI fund since markets bottomed in late October.
Flexibility Could Be Valuable; Provided Manager Is A Good Market Timer
SPYI’s flexible mandate in writing calls vs. call spreads can be a very valuable real option, since the main reason covered call strategies underperform over the long-run is due to low upside capture.
Provided the manager is a good market timer, writing covered call spreads instead of covered calls when markets are ‘cheap’ can lead to better upside capture and higher long-term returns.
Since inception, SPYI has delivered total returns of 14.1% compared to 12.7% for JEPI and 20.3% for SPY, so it appears the managers of SPYI does generate some ‘alpha’ compared to simple covered call strategies (Figure 8).
However, the magnitude of SPYI’s outperformance is not as large as we first observed in my initiation article.
In fact, as we have seen with other ‘dynamic’ covered call strategies like the Nuveen S&P 500 Dynamic Overwrite Fund (SPXX), active management can actually lead to long-term underperformance.
Upon closer examination, SPYI’s flexibility in writing covered calls vs. covered call spreads can be very valuable, especially after sharp market declines, when writing covered calls can truncate returns and lead to underperformance.
So far, the managers at Neos have demonstrated alpha, so I am upgrading it to a relative buy against other Covered Call funds. I will continue to monitor SPYI’s performance and may change my recommendation in the future if SPYI’s relative performance deteriorates.