JPMorgan Nasdaq Equity Premium Income provides attractive income by forgoing the upside of its growth-heavy index. The strategy benefits from an experienced options manager and thoughtful implementation, but downside risk and opportunity cost weigh heavily on this fund.
This fund combines a systematic approach to selling one-month call options with an underlying equity portfolio that stays close to the Nasdaq-100 Index. The manager targets 30-delta out-of-the-money calls, leaving modest room to capture the index’s upside. He reduces the path dependency of its options strategy by staggering its one-month calls into weekly tranches. The fund uses equity-linked notes, or ELNs, that mimic the profits on written call positions instead of holding the options themselves. Tax treatment of ELNs is often favorable for capital gains on equity returns but can be disadvantageous for options profits. ELNs carry additional counterparty risk, but the team at J.P. Morgan diversifies its issuer risk and transacts only with global financial institutions that pass their regular counterparty risk monitoring.
Using a more volatile and growth-leaning index allows the strategy to capture larger volatility risk premiums but runs the risk of eroding total returns over a full market cycle. The eye-catching premiums that the fund has paid out so far have come from selling the upside on the Nasdaq-100 Index, which consists mostly of high-growth stocks. During rallies, the fund doesn’t participate past the short call strike price and pays out its call premiums and dividends as distributable income. The strike price on its calls averaged around 2.5% historically, its upside cap for the one-month period of the calls. For context, more than 40% of the index's monthly returns since its inception exceeded 2.5%, with most up-months clocking in between 2.5% and 7.5%. The fund’s short track record has so far coincided with high implied volatility and high interest rates, which boded well for its call premiums. However, it’s unclear whether the income will be enough to compensate for the forgone upside on the Nasdaq-100 Index in the long run when market volatility calms down.
During drawdowns, this strategy’s options income offsets some losses, and the higher implied volatility often translates to higher call premiums. However, sharp declines and the high volatility associated with the Nasdaq-100 Index exposes the fund to material downside risk. The equity sleeve has offered modest incremental improvements over the index, which may address this issue on the margins. But tight tracking error allowance and similar beta exposure leaves it exposed to much of the same risk.
The fund’s assets have grown exponentially since the beginning of the year, amassing more than $5 billion as of August 2023. Its options are currently based on the Nasdaq-100 Index, which raises some capacity concerns. The high value of the index (about $15,000 as of September 2023) translates to a higher notional value for its options and creates unique challenges for the fund. Options volume on the index tends to be low relative to its high open interest. While it’s a popular index with ample committed capital, traders navigate more toward the smaller contracts on Invesco QQQ Trust QQQ, an exchange-traded fund that tracks the same index but has lower notional value on its options. Nonetheless, the managers have tools at their disposal to manage capacity, such as further staggering options trades or by using QQQ options, if deemed necessary. Laddering the options on a weekly basis, which they are already doing, also helps.