FEPI: A Covered Call High Yield Tech Play (NASDAQ:FEPI)

Covered call strategies have been all the rage in the ETF world as traders and investors look to juice up income with options overlay. One of the more interesting funds doing this is the REX FANG & Innovation Equity Premium Income ETF (NASDAQ:FEPI). FEPI is an innovative investment product that combines the potential growth of large tech companies with the income generation of covered call strategies. The fund’s primary objective is to offer investors capital appreciation and current income. The ETF was launched on October 11, 2023 and has over $176 million in assets under management.

How does a covered call strategy work? By selling call options on stocks in your portfolio, you grant someone else the right, but not the obligation, to buy your stock at a predetermined price (the strike price) within a specific timeframe. In exchange for selling this right, you receive a premium upfront. This premium is the immediate income generated from the strategy, acting as a cushion against stock price declines to some extent and enhancing overall return on the stock if it remains below the strike price by expiration. It’s a nuanced balancing act-while covered calls provide an income stream and partial downside protection, they also cap the upside potential, making it crucial for investors to judiciously select stocks and strike prices that align with their income goals and risk tolerance.

Inside FEPI’s Portfolio

FEPI’s portfolio comprises primarily of 15 big tech stocks, equally weighted, offering a strategic approach to big tech exposure. These companies form the core holdings of the fund and are the assets against which call options are sold.

Top 5 Holdings

As of April 17, 2024, the top five holdings in FEPI’s portfolio were:

1. PALO ALTO NETWORKS INC (PANW): A multinational cybersecurity company with a weightage of 6.82% and a net value of $12,008,389.00.
2. ALPHABET INC-CL A (GOOGL): The parent company of Google, with a weightage of 6.78% and a net value of $11,940,096.00.
3. ADOBE SYSTEMS INC (ADBE): A multinational software company, with a weightage of 6.73% and a net value of $11,861,250.00.
4. Tesla Inc. (TSLA): An American electric vehicle and clean energy company, with a weightage of 6.72% and a net value of $11,845,290.00.
5. SALESFORCE.COM INC (CRM): A cloud-based software company, with a weightage of 6.70% and a net value of $11,798,864.00.

The sector composition of FEPI is heavily skewed towards the technology sector. This concentration in the technology sector is reflective of the fund’s investment objective, which is to capture the growth potential of the big tech companies.

The current distribution rate is 25.2% given the way the covered call strategy has generated yield, allowing investors to get a lot back in the way of payments.

Comparative Analysis Against Peers

The appeal here is around the income that can be produced, and since covered call strategies limit some of the upside, it makes sense that FEPI has underperformed QQQ as an example in this unrelenting uptrend we’ve had since November in large-cap tech names. Should the market enter a broader correction, I would expect FEPI to outperform on a relative basis by being down less.

Pros and Cons of Investing in FEPI

Like any other investment, investing in FEPI also comes with its set of pros and cons.

Pros

1. High Yield Potential: With a distribution rate of 25.20% as of March 25, 2024, FEPI offers one of the highest yields among covered call ETFs. This high yield is primarily due to the fund’s strategy of writing out-of-the-money call options on highly volatile big tech stocks.
2. Downside Buffer: The fund’s covered call approach can potentially mitigate the impact of price declines on its underlying equity holdings, thereby providing a degree of downside protection.
3. Exposure to Key Tech Stocks: The fund provides direct exposure to some of the leading tech companies, including Apple, Amazon, Google, and Microsoft, which have been key drivers of the stock market.

Cons

1. Concentration Risk: The fund’s concentrated exposure to a small number of tech stocks can increase its volatility and risk.
2. Cap on Upside Potential: The covered call strategy used by the fund caps its upside potential, as any gains beyond the strike price of the sold call options would go to the option buyer.
3. Risk of Underperformance: As observed with most covered call ETFs, there’s a risk of underperformance when the underlying stocks rally significantly.

Conclusion

FEPI is an interesting spin on covered call strategies by focusing on volatile big-cap Tech. It can be a potential investment option for investors seeking high income and exposure to big tech companies. I actually think it can outperform because I’m nervous about technology stock momentum and valuations. Just be aware that this is more about relative outperformance on the downside than just yield alone.

Markets aren’t as efficient as conventional wisdom would have you believe. Gaps often appear between market signals and investor reactions that help give an indication of whether we are in a “risk-on” or “risk-off” environment.

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