The Optimal High-Yield Dividend ETF to Consider with $500

This popular JPMorgan ETF offers an appealing sustainable yield of nearly 10%.

In recent years, specifically during 2022 and 2023, many income investors have shifted away from dividend-paying stocks in response to rising interest rates. This migration led them towards lower-risk options like CDs, T-bills, and bonds, leaving dividend stocks and exchange-traded funds (ETFs) less attractive.

However, the Federal Reserve has made changes by cutting its benchmark rates three times in 2024 and indicating plans for at least two more reductions in 2025. If these cuts occur, it is likely that more investors will gradually start returning to higher-yield dividend stocks and ETFs.

Nevertheless, this transition won’t happen instantly. With the 10-year Treasury yield still around 4.8%, many fixed-income investments continue to offer better yields than most dividend stocks. Therefore, rather than hastily purchasing individual dividend stocks right now, investors may find it wiser to consider a diversified, income-focused ETF that employs covered calls to enhance its yield.

If this strategy piques your interest, you should delve into the JPMorgan Nasdaq Equity Premium Income ETF (JEPQ 1.55%). With a modest investment of $500 in this ETF, you could potentially receive nearly $50 in additional income each year.

Understanding Covered Call ETFs

A covered call occurs when an investor writes a call option on a stock they already own. By selling this call, the investor receives a premium, while the buyer gains the option to acquire the stock at the agreed strike price by the expiration date. If the stock does not meet the strike price by that date, the investor keeps the premium and retains the stock. However, should the stock's price rise above the strike price, the investor has to sell the stock to the call holder at that price.

For instance, suppose an investor buys 100 shares of Apple at $100 each and is willing to sell them at $250. If Apple's stock is currently trading at $230, the investor could sell a covered call with a strike price of $250, set to expire on January 31. This option is valued at $0.94, meaning a single contract (tied to 100 shares) would yield a premium of $94.00 (excluding fees). If by January 31, Apple’s price remains below $250, the option expires worthless, and the investor retains both the stock and the premium. Conversely, if the stock escalates to $260, the investor must part with the shares at the $250 price.

This covered call strategy can be beneficial in a stagnant market that fluctuates sideways, but it caps potential gains in a bull market as consistently rising stocks may be sold off. Still, many investors adopt this method to increase their income.

Since continually selling covered calls on individual stocks can be tedious and time-consuming, numerous financial institutions now offer ETFs that automatically manage covered calls for diversified stock baskets to generate steady income. This approach typically results in yields that exceed those of traditional dividend-focused ETFs.

Why You Should Consider the JPMorgan Nasdaq Equity Premium Income ETF

The JPMorgan Nasdaq Equity Premium Income ETF comprises 103 stocks that closely replicate the Nasdaq-100 index. This ETF actively writes covered calls on the Nasdaq-100 each month, distributing payments monthly with a current 30-day SEC yield of 9.76%. Furthermore, it boasts a low expense ratio of 0.35%.

Instead of directly engaging in covered calls, the ETF utilizes equity-linked notes (ELNs) that are associated with covered calls. This additional layer enhances tax efficiency compared to conventional covered calls, which are subjected to short-term capital gains taxes with each transaction.

As it invests in companies within the Nasdaq-100, the ETF offers a diversified portfolio. Its top holdings include leading companies like Nvidia, Microsoft, Amazon, and Apple. As of the latest information, it trades at $55.50—slightly below its net asset value (NAV) of $55.95—providing investors access to its underlying stocks at a minor discount.

The ETF's high yield is attributed to the premiums collected from writing covered calls on more volatile stocks, generating more substantial gains compared to less unpredictable stocks. Although this can introduce some volatility, the ETF’s diversification manages that risk while allowing for consistent monthly payouts instead of focusing solely on the highest-priced covered calls.

Because of these features, the JPMorgan Nasdaq Equity Premium Income ETF presents a reliable means to obtain nearly a 10% yield in a fluctuating market. While it may not be the ideal choice for those seeking aggressive growth, it is a solid avenue for generating supplementary income during sideways market conditions, continuous premium generation from covered calls.

Note: The authorship of this article is neutral without reference to any specific publication.

ETF, Dividend, Investment