Why the NUSI ETF Underperformed in the First Half of 2022

Vineel Bhat | 08/19/22

NUSI ETF and Performance Overview

The Nationwide Nasdaq-100 Risk-Managed Income ETF (NUSI) is a popular fund which uses an options collar strategy on the Nasdaq-100 index, with the intention of generating income while providing downside protection. It stands next to dozens of other “covered call” ETFs which employ options to achieve income generation goals (e.g., QYLD, QRMI, QCLR, JEPI, FTHI, PBP). However, in the first half of 2022, NUSI (having downside protection as a major selling point) has not only underperformed the Nasdaq 100, but also all 6 of the other covered call ETFs mentioned previously, many of which do not actually intend to provide downside protection.

Source: Invessential.com; data from Nasdaq, Inc.

This has been shocking and frustrating for many NUSI investors, as seen in message boards on websites such as Yahoo Finance, which are filled almost entirely with negative comments. Given the fund’s large outperformance during the COVID-19 stock market crash, the large underperformance during the current downturn was unexpected. The secret to what happened, however, lies in the underlying options strategy used by the management team.

NUSI Strategy vs. Other Covered Call ETFs

NUSI: To provide income generation and downside protection, NUSI utilizes what’s known as a collar strategy: selling covered call options on the Nasdaq-100 index and using a portion of the premium to buy protective put options. Typically, NUSI sells the covered calls at a strike price equivalent to the current price and buys the puts at a strike price lower than the current price. Sometimes, though, the calls may be sold at a strike slightly higher than the current price and the puts may be bought at a strike significantly lower than the current price, but the fund does not specify further in their prospectus. All options are set to expire one month from the time of purchase or sale, and upon expiration, a new collar is set. The collars are designed to provide a net-credit, primarily done by placing the puts more out of the money than the calls. NUSI’s strategy limits most of the upside in the Nasdaq-100 because of the restrictive covered calls; however, because the strike of the call is sometimes slightly out of the money, the upside is usually not zero in a bull market. Meanwhile, the put options prevent major downside in the case of a rapid selloff; however, if the market experiences a moderate selloff in which the strike of the put is not reached within a month, investors take the entirety of the downside. Of the net premium received by NUSI (revenue from calls – cost of puts), most is returned to shareholders in the form of a dividend, while some proceeds may be reinvested back into the fund to keep the ETF price afloat.

Symbol	Name	Strategy
NUSI	Nationwide Nasdaq-100 Risk-Managed Income ETF	Monthly net-credit collars; varying OTM puts bought and ATM/OTM covered calls sold
QYLD	Global X Nasdaq-100 Covered Call ETF	Monthly covered calls; all options sold ATM; significant amount of premium reinvested
QRMI	Global X Nasdaq-100 Risk Managed Income ETF	Monthly net-credit collars; 5% OTM puts bought and purely ATM covered calls sold
JEPI	JPMorgan Equity Premium Income ETF	80-85% of capital in low volatility equities, 15-20% in ELNs selling uncovered calls

Options strategies used by popular covered call ETFs to generate income and/or provide downside protection.

QYLD: With income generation the sole goal, QYLD only sells covered calls on the Nasdaq-100 index. The calls are sold at a strike price equivalent to the current price: although the fund prospectus mentions that calls can be sold at a strike above the current price, since the fund specifies ATM (at the money) calls in other documents, it can be assumed that selling OTM (out of the money) calls is a very rare occurrence. These ATM covered calls set to expire one month from the time of sale, and upon expiration, a new covered call is sold. QYLD’s strategy limits all of the upside in the Nasdaq-100 because of the restrictive covered calls, and investors are also exposed to all of the downside in the index because the fund does not purchase protective put options. Of the premium received by QYLD (revenue from calls), some is returned to shareholders in the form of a dividend, while a solid portion is reinvested back into the fund to allow for share price recovery.

QRMI: Like NUSI, QRMI seeks to provide income generation and downside protection using a collar options strategy on the Nasdaq-100 index. However, compared to NUSI, the fund follows a stricter set of rules, and the fund prospectus is more detailed regarding the options thresholds used by the management team. QRMI always sells covered calls at a strike price equivalent to the current price (or closest to current price available) and buys puts at a strike price 5% lower than the current price (or closest to 5% below available). All options are set to expire one month from the time of purchase or sale, and upon expiration, a new collar is set. QRMI’s strategy limits all of the upside in the Nasdaq-100 because of the restrictive covered calls, while the put options prevent major downside in the case of a rapid selloff. Like NUSI, however, if the market experiences a moderate selloff in which the strike of the put is not reached within a month (<5% selloff in a month), investors take the entirety of the downside. Net premium is returned to shareholders (dividend) and reinvested.

JEPI: To meet the fund’s goals of income generation and low volatility, JEPI aims to invest 80-85% of the fund’s capital in a group of stocks which have lower volatility than the S&P 500 index, and the other 15-20% in equity-linked notes (ELNs). While the stocks provide some income from dividends, almost the entirety of the large yield JEPI boasts comes from the 15-20% it invests in ELNs. These ELNs comprise of zero-coupon bonds and long call options on the S&P 500 index [JEPI specific] (see more on how ELNs work here). In the case of JEPI, the ELNs additionally sell calls (not covered) on the S&P 500 index to generate premium. Typically, the ELNs and options are set to mature or expire one week from the time of purchase or sale, and upon maturity or expiration, new ELNs and options are purchased or sold. Note: It is important to note that although ELNs are touted as “principal protected”, there is counterparty / credit risk as the seller of the zero-coupon bonds may default. Further, ELNs are highly illiquid as they are not regularly traded in the secondary market, and are therefore usually held till maturity. JEPI’s strategy limits some of the upside in its equity portfolio as the losses from naked call options offset investment gains in a rising market. But in a rapid or moderate selloff, investors will likely fare better than the overall market, as the equity portfolio is designed for low volatility and the call options sold will likely expire worthless. A portion of the premium generated by the fund/ELNs is returned to shareholders in the form of a dividend.

Why NUSI Stock Price Lagged in the First Half of 2022

Despite touting downside protection, NUSI’s stock price lagged the Nasdaq-100 in the first half of 2022, primarily due to the moderate pace of the 2022 market selloff. Based on the fund’s performance during the COVID-19 stock market crash, we can assume NUSI buys puts on the Nasdaq-100 index about 8-12% out of the money, although some puts could be bought at even lower strikes, as mentioned in the prospectus. Year to date, though, the Nasdaq-100 index has only achieved a one calendar month downturn greater than 12% once – a 13.5% drop in April. This means that all of the monthly put options purchased by NUSI either expired worthless or provided nominal gains, leaving investors to realize the majority of the downturn in the underlying index. Meanwhile, during bear market rallies of 2022, while the Nasdaq-100 made significant strides, NUSI forfeited a large portion of upside in the index because of its use of covered call options.

In essence, investors caught nearly all downside in the downturn due to the far placement of put options, while participating in just a fraction of the upside during bear market rallies due to restrictive covered calls. This double whammy resulted in NUSI underperforming the Nasdaq-100 index in the first half of 2022 and also up until the time of writing this article in mid-August. Although NUSI’s strategy for downside protection (relatively deep OTM puts) works well in a rapid, high magnitude crash (e.g., COVID-19 crash) as the puts cap monthly losses at around 8-12%, it falters during a moderate, dragged selloff as the put strikes are not reached and investors realize nearly full downside.

Symbol	Name	Primary Reason for Outperformance	1H '22 Excess Return
NDX	Nasdaq-100 Index	Moderate pace of the 2022 market selloff	1.47%
QYLD	Global X Nasdaq-100 Covered Call ETF	Greater portion of premiums reinvested	9.98%
QRMI	Global X Nasdaq-100 Risk Managed Income ETF	Protective puts placed less out of the money	14.66%
JEPI	JPMorgan Equity Premium Income ETF	Selection of lower than SPX volatility stocks	19.48%

Primary reasons for outperformance over NUSI in the first half of 2022, excess price returns over NUSI in the first half of 2022 for the Nasdaq-100 and popular covered call ETFs.

The reason why NUSI underperformed other covered call, collar, and ELN ETFs is more complex. In the case of QYLD, there are no protective put options purchased, which means the fund keeps 100% of the premium it collects from the sale of call options. As a result, a greater portion of the premium generated is reinvested back into QYLD, supporting the stock price to a greater degree than NUSI can afford (due to the costs of the protective put options it purchases). Although the puts are meant to provide downside protection, NUSI’s relatively far away strikes during this dragged selloff means that the protection is barely noticeable, as detailed previously. Thus, the stock price support provided by NUSI’s puts has been lower than that generated by QYLD through reinvesting a larger portion of the covered call premium it keeps in its entirety, leading to QYLD’s relative outperformance throughout the first half of 2022 and mid-August.

Although QRMI, QYLD’s companion collar ETF, does purchase puts in addition to covered calls, it has also outperformed NUSI because its put strikes are likely less out of the money. Since QRMI buys 5% out of the money puts with expiration a month away, this limits one month drawdowns to 5%. Meanwhile, NUSI’s puts are likely placed 8-12% out of the money, so the fund is only limiting monthly drawdowns to 8-12% (2x QRMI). Given this dynamic, QRMI will almost always outperform NUSI during a market downturn, as we are seeing now. However, these less OTM puts are costly, meaning QRMI will usually provide a lower dividend yield compared to QYLD. And compared to NUSI, both QYLD and QRMI lack the same degree of upside due to their use of strictly ATM covered calls. The tradeoff here is between price support (QRMI) and upside (NUSI).

Finally, NUSI has underperformed JEPI due to the differences in how they operate. JEPI does not buy put options, and rather than selling covered call options, generates income through investing 15-20% of capital in ELNs (which here, in essence, can be thought of like highly leveraged exposure to selling uncovered calls). Further, while NUSI invests in the volatile Nasdaq-100 index, JEPI aims to invest in a portfolio of equities with lower volatility than the S&P 500 index. The crux of JEPI’s outperformance is because in this falling market, JEPI is not subject to major losses from the calls it sells, while its portfolio of lower volatility stocks are better able to whether the storm compared to the Nasdaq-100. Although NUSI is meant to provide downside protection, the moderate nature of the current downturn lends the intended protection nearly worthless. Therefore, both the Nasdaq-100 index and NUSI have underperformed compared to JEPI year to date.

Why NUSI May Outperform in Other Environments

Despite NUSI’s lackluster performance in the current market environment, there may be better days on the horizon.

Namely, the fund’s structure may lead to outperformance compared to its peers in a bull market. Although NUSI’s practice of occasionally selling out of the money covered calls reduces premiums, it means the fund will generally outperform other covered call ETFs such as QYLD and QRMI during a market rally. Since funds like QYLD and QRMI consistently sell at the money covered calls, they forfeit the all of the gains in the underlying index, while a fund like NUSI can take small strides.

However, NUSI’s price appreciation will still lag that of the underlying Nasdaq-100 index, as any covered call by nature forfeits a degree of upside. Given that the covered calls NUSI sells are rarely sold significantly out of the money, hefty underperformance compared to the Nasdaq-100 can be expected in a market upturn, despite being able to outperform some of its covered call peers in such an environment.

Both of the previously mentioned dynamics can be seen in NUSI’s performance during the August bull run.

Source: Invessential.com; data from Nasdaq, Inc.

While NUSI performed the worst in this basket of 8 covered call ETFs from January to July (-31.26%), it performed the best out of all the funds from July to August 18th at the time of writing (+8.64%). Still, it performed worse than the Nasdaq-100 in both time periods (1.47% underperformance from Jan-Jul and 5.66% underperformance from Jul-Today).

Ultimately, though nearly all covered call ETFs underperform their underlying indices in a bull market, NUSI may have a sizable edge against some of its peers in such an environment due to its sale of out of the money covered calls.

Dividend Comparison

It is important to note that this article focuses purely on price appreciation and not on dividends. While NUSI and many funds similar to it (e.g., QYLD, QRMI) distribute dividends on a monthly basis, NUSI generally yields lower than many of its peers, primarily due to the extra cost of purchasing put contracts and the loss of premium in selling some out of the money covered calls (versus at the money in many funds). However, with the dividend yield, NUSI did outperform its underlying index – the Nasdaq-100 – at times, though it was usually by small margins.

Symbol	Name	TTM Dividend Yield	1H '22 Total Return
NDX	Nasdaq-100 Index	N/A	-29.50%
NUSI	Nationwide Nasdaq-100 Risk-Managed Income ETF	9.36%	-28.51%
QYLD	Global X Nasdaq-100 Covered Call ETF	14.61%	-16.27%
QRMI	Global X Nasdaq-100 Risk Managed Income ETF	9.34%	-13.75%
JEPI	JPMorgan Equity Premium Income ETF	9.38%	-7.08%

Dividend yield (TTM) and total return in the first half of 2022 (including dividends reinvested) for the Nasdaq-100, NUSI ETF, and other popular covered call ETFs.

Conclusion

NUSI has underperformed the market and its peers in the first half of 2022 due to its far placed puts and restricting covered calls. While its puts don’t protect against moderate declines, its calls restrict most of upside in the underlying index.

The frustration in the investing community regarding NUSI’s performance, which was unexpected by some, highlights the need to conduct due diligence before investing in any ETF or asset – especially ones with more complex structures. Often times, investment products use exaggerated or misleading marketing to appeal to investors – which makes knowing what you’re investing in at an in-depth level more crucial. It is wise to be especially wary when limited historical data is available.

For those investing in the covered call ETF space, small differences in structure can make a big difference. For example, the strike price thresholds for options and the percent of capital allocated to different assets. NUSI outperforms during a rapid crash but gets stomped on during a moderate selloff – and in a rising market it may outperform its peers but will underperform its underlying index in terms of price appreciation. QRMI works in a similar way but can better weather selloffs of any magnitude, though at an increased cost reflected in a lower dividend yield. QYLD provides big yields and can usually march out of a stock price rout through reinvesting premiums, but provides no downside protection and very little upside during a bull market. And JEPI has a bit of everything – high yield, generally lower volatility, and some upside during a market rally. However, JEPI has its own set of risks from the ELN structure it uses, which is sometimes confused with the more traditional covered call strategy employed by some of its peers. The ELNs JEPI invests in are highly leveraged and come with credit risk on the principal placed in zero-coupon bonds, which should not be ignored.

Income oriented investors interested in the space can benefit from choosing an ETF which best matches their goals. For example, those purely interested in a high dividend yield may invest in QYLD while those looking for a income and a more stable investment may invest in the QRMI, NUSI, or JEPI ETFs. It should also be noted that the at the money covered call strategy – measured by the CBOE S&P 500 BuyWrite ETF (BXM) – has had mixed historical performance in comparison to a simple S&P 500 index. From 1988 to 2004, BXM returned a 12.39% CAGR compared to the S&P 500’s 12.20%, but from 2004 to now, BXM only returned a 5.34% CAGR compared to the S&P 500’s 9.63%. Overall, the S&P 500 has done better since 1988 (10.81% vs. 8.55%), but BXM has had meaningfully lower volatility during that time period. Investing in covered call ETFs usually means you are making a tradeoff between income generation / lower volatility and total return potential.

In the end, the story of NUSI is an interesting one which also has some valuable tidbits of insight for general investing, which I expanded on in detail above. Through this article, I hope you were able to better understand the reason for the fund’s recent performance and the inner workings of these sort of ETFs.

Cheers, and happy investing!

Code

Any code related to my posts (analysis or plotting) is available on GitHub here. Files are named based on the date of the post (e.g., 08/19/2022 for this article). For questions, feel free to contact me at invessentialmain[at]gmail[dot]com.

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Disclaimer: Opinions not advice! I am not a registered financial advisor. All views and recommendations expressed in this article are solely my opinions and should not be considered as financial advice.