Summary
The Nuveen Nasdaq 100 Dynamic Overwrite Fund (QQQX) attempts to combine the best of three worlds for income investing – high dividend, low volatility, and capital appreciation.
With a 6.6% dividend yield, it is indeed appealing to investors seeking current income.
However, you need to be aware of the uncertainties ahead, particularly surges in volatility and interest rates.
The recent volatility spike and expected volatility ahead can help it generate more income but pressure its price appreciation.
At the same time, the expected interest rate raises can diminish its real return and increase investment risks.
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BrianAJackson/iStock via Getty Images Thesis
I first wrote about the Nuveen Nasdaq 100 Dynamic Overwrite Fund ( QQQX ) on July 25, 2021. That article analyzed the inner workings of QQQX . It took a close look in terms of its dividend, dividend growth, and volatility, and concluded that the fund indeed delivers a high income and also a handsome total return.
Fast forward to now, it pays a 6.6% dividend yield. Overall, it is indeed an appealing fund to investors seeking current income. However, if you are considering this fund, you need to be aware that the fundamental dynamics have changed quite a bit since I last wrote about it. And it is the goal of this article to discuss these changes, so you become informed of the uncertainties ahead. These fundamental changes are: Volatility. In July 2021, the market was experiencing some of the quietest volatilities. The VIX index was about 17 at that time. Recently, volatility has spiked to more than 35 and current is at 22.
Interest rates. In July 2022, we were also experiencing near-record low-interest rates, and the 10-year treasury bond rates were only 1.29% at that time. Recently, interest rates have also spiked and 10-year treasury bond rates are now at 1.93%, a whopping 64 basis points higher. And more raises are expected ahead.
And we will discuss the implications of these macroeconomic forces for QQQX’s income generation and price prospects immediately below. Volatility Spike
According to its issuer, Nuveen, the fund is designed to achieve low volatility as one of its specific goals (the highlights are added by me): The Fund is designed to offer regular distributions through a strategy that seeks attractive total return with le ss volatility than the Nasdaq 100 Index by investing in an equity portfolio that seeks to substantially replicate the price movements of the Nasdaq 100 Index, as well as selling call options on 35%-75% of the notional value of the Fund’s equity portfolio (with a 55% long-term target) in an effort to enhance the Fund’s risk-adjusted returns . At my last coverage in July 2021, the volatility (COBE VIX around 17) was at its quietest level as you can see from the following chart. To put things under perspective, a VIX around 17 is at the 48% percentile of VIX’s historical spectrum, i.e., below the historical average. And the VIX dropped to even lower levels during Oct and Nov to about 15. And a VIX around 15 is only at the 30% percentile of its historical spectrum.
However, recently, the volatility has spiked substantially due to a range of macroeconomic forces such as the new COVID variants and the Fed’s hawkish dot-plot (which we will elaborate more on in the next section). As a result, the VIX index peaked above 35 in Dec 2021 and stayed relatively high up to now. Currently, it hovers around the 22.5 level. Again, to put things under perspective, a VIX around 32 is already at the 95% percentile of VIX’s historical spectrum, and a VIX around 22.5 is at 75% percentile.
Such a volatility surge could be bad news for equity investors in general, but it can be good news for income investors using the call-writing strategy that QQQX employs. Writing (or selling) calls is like selling anything else in that the amount of the premiums the sell can charge changes as the demand-supply dynamics change.
Because of such dynamics, potential investors now face a mixed signal. On the one hand, a hike in income distribution can be expected because the VIX has been at a relatively high level (again, above the 75% percentile of VIX’s historical spectrum) in the past few months. But on the other hand, the higher volatility does create pressure on the price of the underlying […]
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