We explore the free dividend fallacy and how it applies to option income strategies. We break down the return drivers of covered call ETFs and examine the long-term performance record and volatility. Finally, we explain why it’s better to own a single stock than a single-stock covered call ETF like MSTY, NVDY, or TSLY offered by YieldMax.
Show Notes
The Dividend Disconnect by Samuel M. Hartzmark and David H. Solomon—Ivey
Sam Hartzmark on Dividends—Meb Faber Research
The New American Hustle: Dividends Over Day Jobs by Denitsa Tsekova and Vildana Hajric—Bloomberg
Covered Calls Uncovered by Roni Israelov and Lars N. Nielsen—Financial Analysts Journal
Investments Mentioned
Invesco S&P 500 BuyWrite ETF (PBP)
JPMorgan Equity Premium Income ETF (JEPI)
WisdomTree Equity Premium Income Fund (WTPI)
YieldMax TSLA Option Income Strategy ETF (TSLY)
Tesla (TSLA)
YieldMax NVDA Option Income Strategy ETF (NVDY)
NVIDIA (NVDA )
YieldMax MSTR Option Income Strategy ETF (MSTY)
Strategy (MSTR)
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Related Episodes
471: Unlocking Income—A Comprehensive Guide to Investing in Covered Call ETFs
466: Does Dividend Investing Still Work?
Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 557. It’s titled “Don’t Fall into the Dividend Trap.”
Free Dividend Fallacy
Now, what do I mean by dividend trap? Well, there’s something called the free dividend fallacy. At times, individual investors, even institutional investors, they forget that dividends aren’t free money. For example, when I was an institutional investment advisor—this was in the early days—we would pull together performance reports for our institutional clients.
And one of the things you learned as an analyst is that when a mutual fund pays a dividend, the price drops, because it has cash that makes up its net asset value, and then when it pays the dividend, you see the drop. And sometimes, someone—an entity like Morningstar—they might not pick it up right away.
And I’ll often get emails from listeners, like “How did this ETF lose so much money today?”, when in fact what happened was whatever service they were using didn’t pick up the dividend, and so it looked like there was a bigger loss because the price dropped, because of the dividend payout. And that’s just how the math works.
And so as an institutional advisor, sometimes we would be calling up the mutual fund company and say, “Did you pay a dividend? Because we’re trying to figure out why it was a loss.” So there are some traps when it comes to dividends.
The other dividend trap is not recognizing that the dividends are not separate from capital gains. For example, there’s surveys where 70% of individual investors in this survey didn’t realize with an individual stock when it paid a dividend, in theory, the stock’s price should drop. And sometimes it does; it doesn’t always. But if they’ve just given away a bunch of money, cash, and dividend, then the stock should be worth less based on financial theory.
We care about this dividend trap, this free dividend fallacy, because one of the most popular strategies right now are option income strategies. Two of the three largest actively-managed ETFs are by JP Morgan and their equity income ETFs.
In fact, if an ETF sponsor puts income in their ETF name, they actually can charge more. Income ETFs have a higher expense ratio. The market supports that because individual investors so highly value dividend income, and they don’t always realize its connection to the capital gains, particularly when it comes to option income strategies. And that’s what we’re going to look at in today’s episode, is sort of break it down, “What drives the return of option income strategies?” And we’re going to break it into the various parts.
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