Nasdaq 100 Option-Income ETF: Is the Sequel to JEPI Just Theater? by Steve Abramowitz

Sequels are made by film studios trying to capitalize on the success of the original release. Rocky II became another blockbuster for MGM Studios. J.P. Morgan’s Nasdaq Equity Premium Income ETF (JEPQ) is an audience-pleaser right in our own backyard. It’s the glitzy younger sister of the star of the active ETF world, J.P. Morgan’s Equity Premium Income ETF (JEPI).

Like most sequels, the new technology-oriented fund borrows a good bit from its predecessor. It’s on a pace to be just as big a moneymaker, attracting almost half of JEPI’s assets in its first two years of operation. The J.P. Morgan version of the Nasdaq 100 fund also contains only slightly fewer stocks than JEPI and costs .35, considered very reasonable for an actively managed fund. As an option-income offering, it trades considerable upside potential for a very high distribution rate.

JEPQ’s portfolio managers can sell options on their high-volatility stocks for a higher price than can their counterparts at the more conservative and better-diversified JEPI. This feature allows the tech-heavy ETF to offer a higher yield (recently between 9%-11%) than JEPI (7%-8%), but with a treacherous liability.

Like all option-income funds, the two J.P. Morgan ETFs have unlimited downside risk because the sold options provide only partial protection against a steep decline. With its 40% weighting in technology, the more recently issued JEPQ’s downside vulnerability is greater than JEPI’s. How much greater? Let’s take a look.

On Tuesday, September 3^rd, stocks were clobbered, with the Dow cascading over 600 points. The Nasdaq 100 index itself lost 3.0%, whereas its JEPQ surrogate surrendered 2.0%. This supports the fund sponsor’s assertion that its tech-powered fund is likely to participate in about 70% of losses in the underlying index.

Whether readers see that percentage as too dicey or an acceptable degree of exposure will, of course, depend on their investment goals and risk-tolerance. Interestingly, the S&P 500 declined 2.1% on the same day, likewise reinforcing J.P. Morgan’s expectation that the Nasdaq 100 option-income fund is roughly about as volatile as the broad market. It may be that the income from option sales balances out the jumpiness of technology stocks.

How did JEPI do this past Tuesday? The darling of the active option-income crowd slumped just 0.6%, once again demonstrating its resilience in the midst of market turmoil. This result only strengthens the case for use of the fund as a high-yielding bond substitute in a balanced portfolio.

On that score, it is pertinent to note that both funds pay their dividends monthly, but also that those dividends are not as stable as stock dividends or bond interest. That’s because most of the funds’ payouts derive from the proceeds of option sales rather than the more constant dividends of their individual holdings. In times of market turmoil, traders are willing to pay higher prices for their leveraged option plays

These observations invite two inferences. First, retirees who prefer to receive the same income month after month to cover everyday living expenses may not be satisfied with a variable—even if higher—dividend. On the other hand, when JEPI (but not the more racy JEPQ) is deployed alongside a traditional fixed-income fund in a portfolio, fluctuation in its option-generated income may be muted by the steady bond interest.

JEPI’s durability makes it a promising candidate to deter a potentially disastrous sequence of returns right before or early in retirement. Why choose concentrated and bouncy JEPQ for the stock sleeve of your diversified portfolio at that critical juncture when it is no safer than the S&P?

But might the Nasdaq 100 option-enhanced ETF be helpful as a satellite holding during the accumulation phase? Let’s get a little granular again. In the 2023 recovery from the previous year’s turbulence, the technology-laced Nasdaq 100 index advanced a remarkable 55%. Its option-based proxy rallied a comparatively modest 36%, capturing barely 65% of the gain of the index. The corresponding figure year-to-date through August was a more robust 82%. Notice that, when averaged, the participation rate was just over the 70% expected by the ETF’s issuer. Why limit the upside thrust of the technology sector, when outsized gain is the reason you wanted that overweight in the first place?

We saw how JEPI could be a useful adjunct around the time of retirement, but what about in the accumulation phase? Decidedly not. In 2023, J.P. Morgan’s flagship ETF could muster only a disappointing 10% total return as compared to the broad market’s 26%, a paltry 38% of the S&P’s performance. This year has not been any kinder to the fund, which through August rose only 11%, or merely 58% of the year-to-date change in the S&P. We have reaffirmed that JEPI offers an unorthodox way to protect against a harrowing sequence of returns, but that it is woefully inadequate as a total return vehicle earlier in a person’s investment program.

Regrettably, the Nasdaq 100 option-income ETF is simply too narrow and too ornery for the stock portion of a retirement portfolio in the distribution phase. The fund is likewise best not cast in a supporting role during accumulation because its short options work as a partial brake on performance.

What have we learned about J.P.’s sequel to its better-diversified and fabulously lucrative blue chip JEPI? One could say that because an option-selling strategy smooths out some of the market’s mayhem, it may help keep investors from bailing out from their funds at just the wrong time. But this is a big price to pay for an ETF whose distributions are treated as ordinary income and so is only advisable in more tax-friendly accounts.