QDTE vs JEPQ. Both ETFs are two very popular funds among yield-seeking investors. Both of them use covered call strategies to generate high dividend distribution yields. But, which one is better? Let’s take a look.

QDTE vs JEPQ: Benchmark Tracking Construction

Right of the bat, we see that QDTE charges a higher fee of 0.95% compared to 0.35% for JEPQ. Returns vary from year to year, but fees are always subtracted. While not the costliest, QDTE ranks in the second-costliest quintile of US Fund Large Blend category according to Morningstar.

QDTE’s Synthetic Exposure to Nasdaq-100

Both QDTE and JEPQ use Nasdaq-100 as their benchmark. But, there are certain subtleties between the two. While QDTE tracks Nasdaq-100, Roundhill calls it “Innovation-100 index”. In reality, it is just the plain old Nasdaq-100. They removed the Nasdaq-100 references from their marketing materials long ago. Otherwise, they would have to pay licensing fees.

When comparing QDTE vs JEPQ, we see that QDTE does not invest in actual stocks in Nasdaq-100. Instead, they buy deep in-the-money call options on the index. These options are also called long-term equity anticipation securities (LEAPS). They are a type of index option with much longer expiration dates as compared to standard contracts. If you look at their holdings, this is what we see.

We see these LEAPS call options on Nasdaq-100 and some investment in US Treasury fund. By using LEAPS, QDTE gains the same exposure to Nasdaq-100 as if buying the actual Nasdaq-100 stocks. But, call options are leveraged securities. This means that Roundhill needs less capital to have exposure to NDX. The main risk with synthetic exposures like this is counterparty risk.

Also, call options that QDTE invests in are of so-called FLEX type. They differ from standard option contracts, as they are customizable. The drawback of FLEX contracts is that they are not as liquid. This may generate higher trading costs for QDTE. And, if markets go wild, FLEX options may behave not as expected if trading volume thins out. Most of the time, FLEX options are fine. But, in high stress situations, stuff can happen.

JEPQ’s Benchmark

Conversely, JEPQ holds stocks in Nasdaq-100 directly. But, they are not one-for-one. JPMorgan says that its goal is lower volatility over 3-5 years compared to Nasdaq-100. So, they probably use models to pick stocks for lower variability of returns.

The benefit of the focus on lower volatility is that JEPQ may have lower drawdowns and lower Sharpe ratios, especially in bear markets.

Covered Call Funds Quick Primer

Next is the covered call strategy. You probably heard about it before. It involves selling call options on the underlying portfolio of stocks or Nasdaq-100. By doing so, JEPQ and QDTE generate premium income, which they distribute to investors.

But, of course, there is a catch. By selling call options, these funds cap their upside. A known issue with covered calls funds is that they tend to lose money and trail benchmarks in bull markets. At same time, they may provide some downside protection, but it is limited to sold option premium. In other words, covered call funds prevent investors from participating in bull markets and still expose them to downside.

Where QDTE and JEPQ thrive and may even outperform Nasdaq-100 is in sideways markets. Meaning, they will get better returns when the stock price goes nowhere. This allows covered call funds to generate large premium income without capping their upside.

QDTE vs JEPQ Covered Calls Strategies Comparison

There are differences in how these funds use covered call strategies. JEPQ does not sell call options directly. Instead, it relies on so-called equity linked notes or ELNs. ELN is a structured investment product that sells call options and distributes income to its holders. Conversely, QDTE sells call options directly.

Taxation Comparison of QDTE vs JEPQ

QDTE’s distributions are classified as capital gains most of the time. Depending on the holding period, these gains could be either short-term (less than one year) or long-term. Long-term capital gains are taxed at preferentially lower rates. Unfortunately, because QDTE constantly sells short-dated call options, most of its distributions are likely to be short-term capital gains. Short-term capital gains are taxed at regular tax rates.

As for JEPQ, its covered call income from ELNs is considered to be an interest income. Interest income is taxed at regular tax rates. Either way, if you don’t need income right away from QDTE or JEPQ, it is best to hold them both in tax-deferred accounts. Otherwise, you will be paying unnecessary taxes, which could be higher for JEPQ.

Sometimes, distributions from JEPQ or QDTE may be classified as return of capital. I will come back to this shortly, as it can be detrimental to shareholders in certain cases.

0DTE Options Explained

There is another difference between QDTE vs JEPQ. JEPQ sells call options that expire at least a certain number of days into the future. If we look at their portfolio we see NDX_15 or NDX_17. These are likely equity linked notes that sold call options with expiration of 15-17 days.

Conversely, QDTE is one of the first if not the first ETF that sells 0 days to expiration call options, or 0DTE. How does it work? Every trading day, a Roundhill portfolio manager for QDTE wakes up, and looks at the market. Then, he sells the 0DTE option at market open or just shortly thereafter.

0DTE options expire by the end of that same day either completely worthless or in the money. Worthless happens when Nasdaq-100 stays below the strike price of 0DTE options. That’s an ideal situation for QDTE. Because they get to keep the premium and not owe anything. But, if Nasdaq-100 rallies above the option strike price by the end of the day, QDTE will lose money on this position.

0DTE Risks

So what kind of unique risks do these 0DTE options expose QDTE to? First off, with 0DTE options, their price moves can be very sharp and more unpredictable. For instance, markets can start in pessimism at or around 9:30am. But, when some good news on inflation or production comes out, Nasdaq-100 rallies. There are days like that. Conversely, JEPQ’s sold call options with longer durations are likely not subject to such sharp moves.

Also, there are some days when the market can rally big in one day, like really big. It does not happen often, but it does happen. As this occurs, it can obliterate premium income and put 0DTE sold options at a big loss. With longer duration options, it is also a problem. But, at least JEPQ has some days to wait it out and maybe Nasdaq-100 falls.

Overall, it’s just my speculation and we don’t know the long-term results from 0DTE covered call options. For the past six months, things seemed to be going okay for QDTE vs JEPQ. We will have to wait and see I guess.

QDTE vs JEPQ Distribution Yields Comparison

But, one thing is for certain. Selling 0DTE options each day comes with lots of premium income. That is why QDTE is able to make distributions on a weekly basis. If we look into QDTE’s distributions since March of 2024, here is what we see: $8.78 for almost half a year.

If you invested in QDTE on March 7, 2024 at a stock price of $46.44, your annualized distribution yield would be a whopping 41% if you did not reinvest it. In comparison, JEPQ annualized yield stands at about 12%.

It looks like QDTE is a clear winner, right? Well, no so fast. First off, although I annualized its distribution, there is no guarantee that QDTE will be able to sustain it. If we look at weekly distributions, we see a lot of disparity. Some weeks were extremely good, others not so much.

Why is that? The simple answer is volatility. Higher volatility of Nasdaq-100 produces larger premium income for both QDTE and JEPQ. For instance, we see that at the beginning of September 2024 volatility jumped. This has greatly benefited both funds. But when the stock market trended up or was making small moves, the income was really low.

On the other hand, JEPQ makes distributions on a monthly basis. Its distributions also tend to fluctuate, but not as much as QDTE. Here are distributions per share for JEPQ.

In comparison, QDTE distribution amounts tend to jump around more. This is not surprising given its strategy to short 0DTE options. It is exposed to higher volatility of premium income compared to JEPQ.

Such sharp jumps may make it difficult for retirees holding QDTE to plan their budgets. If you are thinking of investing in QDTE and rely on its 40%+ yield, I don’t think that it is a good idea. If markets stop being volatile or interest rates go down, which they seem to, distributions may come down. It will be particularly pronounced for QDTE though.

QDTE vs JEPQ: Total Returns Comparison

And of course, we have to look at total returns for QDTE vs JEPQ. Distribution yield tells only part of the story. Even though QDTE generated $8.78/share distribution, its stock price fell by almost $4. Here is a total return graph starting on March 7, 2024 when QDTE came to existence.

When comparing the performance of QDTE vs JEPQ, the verdict is not clear. QDTE is a new fund. For instance, for the 3 months, QDTE outperformed JEPQ by almost 3% on a total return basis. Same thing happened on a 1-month basis. Since March 7, QDTE outperformed both JEPQ and even QQQ ETF.

This is very intriguing. Will this persist into the future? At this point, we don’t know. In the last 6 months, Nasdaq-100 showed a lot of up and down volatile movements with a sideways pattern. This has benefited QDTE to a larger extent than JEPQ because of those 0DTE options. But, QDTE can underperform JEPQ if there are sharp daily upward movements of Nasdaq-100.

Overall, QDTE and JEPQ will both underperform Nasdaq-100 with almost certainty over long periods. For instance, JEPQ underperformed QQQ by 11% on a cumulative basis since May 4, 2022. QQQ tracks Nasdaq-100 without a covered call strategy. Sure, there could be differences here and there. But, if Nasdaq-100 trends up, which it tends to, JEPQ and QDTE will likely lag its performance. That’s just how covered call funds work by their design.

As for volatility for QDTE vs JEPQ, so far QDTE showed higher fluctuations compared to JEPQ. We don’t know how volatility will play out for QDTE going forward. But, it will probably stay elevated due to the nature of its 0DTE options.

Dividend Reinvestment Assumption

But, there is one huge caveat to all the total returns numbers we just saw. Total returns for all these funds are dependent on you reinvesting their distributions. In fact, total returns stats on Morningstar or Yahoo Finance assume reinvestment of distributions.

Most people invest in QDTE or JEPQ to take out income. This alone grossly lowers total returns for these funds. And, the higher the distribution yield, the more pronounced this return deterioration is. So, without reinvesting, QDTE’s total return will be much lower. Likely, it will an order of magnitude lower compared to JEPQ over a very long period of time.

For instance, since its inception on May 4, 2022, JEPQ returned roughly 39% on a cumulative basis with dividends reinvested. Conversely, without dividends reinvested, its cumulative total return was 31.67%. So, take these total return numbers with a grain of salt if you are planning to keep distributions.

NAV Erosion for Covered Call Funds

Another issue to contend with JEPQ and QDTE is the erosion of your principal or so-called net asset value (NAV) erosion. Net asset value or NAV is the value of all assets that a given fund holds minus any liabilities or debts it owes. Once we net everything out and divide NAV by the total number of shares of a fund, we get NAV per share. It is approximated by the fund’s stock price more or less. So, NAV erosion is just a fancy way of saying that the market price of a fund declines.

NAV erosion obviously happens when a fund generates losses. But, in the case of QDTE and JEPQ, it often happens when they make distributions without generating enough earnings to back them up. This typically happens when there is a loss on covered call positions or their underlying assets decline.

If we look at price per share of QDTE vs JEPQ, we see that since its inception, JEPQ’s price actually grew. Although, there were many down days too. If we zoom in on a 6-month period, it is break even. Conversely, QDTE has seen a large decline in its market price of almost 10% since its inception. This is a sign that QDTE distributions likely exceeded what the fund earned in this period.

When a fund distributes more than what it earns, its distributions count as return of capital for tax purposes. Return of capital distributions do not generate taxes right away. Instead, they lower the investor’s cost basis of an investment. So, in a sense, it is a tax deferred gain. When you sell your QDTE shares in the future, you will record a larger capital gain due to lower cost basis.

NAV Erosion Leads to Declining Distributions

So, why is this discussion of NAV erosion important? Because if a fund’s NAV per share starts to go down long-term, the fund may have less capital to generate income. And, when that happens, your yields on initial investment will plummet.

In a sense, it is like QDTE is giving your money back instead of reinvesting capital to generate income and capital gains. One way to counter NAV erosion is to reinvest your distributions into QDTE or some other ETF.

How Much to Reinvest to Counter NAV Erosion?

The simple back-of-the-envelope way to figure out how much you need to reinvest is to look at the price action and see where it stands in a year or some other longer period of time. It is possible that the recent decline in QDTE price is temporary and it may rebound. If not, you may have to reinvest at least part of your distributions.

For instance, the price decline for QDTE was roughly 10% or $4 from March to October. Over the same period, QDTE investors received $8.78 in distributions. So, you will have to reinvest at least $4 or 45% of your distribution income to counter NAV erosion. Of course, this is a rough and imprecise estimation. Conversely, if we look at JEPQ, it did not show NAV erosion since inception.

I think that to assess NAV erosion, it is best to look at longer periods of time, like at least several years. As I mentioned, both QDTE and JEPQ prices tend to fluctuate. And, while QDTE is down, it may recover and there will be no need to replenish your principal.

You can also go and check for yourself how these funds accounted for distributions using their financials. For instance, here are financial statements for QDTE accessible through their website.

It started with a NAV/share value of $45.72. For the period ending on June 30, QDTE generated investment income of $3.47, but distributed $3.78. We see that distributions exceeded its income. The NAV/share decreased slightly.

Potentially, there is some part of the return of capital sitting here. But, in another statement, QDTE says that its distributions were from earnings and none were of return of capital. This could be differences between financial and tax accounting numbers. Of course, this is just six months or so. We will have to wait for the entire year to see what happens.

Investors Takeaways

So, overall I am against vilifying or glorifying any ETF. Clearly, QDTE vs JEPQ have their own costs and benefits. With QDTE pursuing 0DTE strategies, it is much riskier and may or may not match JEPQ’s total returns long-term. Playing with 0DTE options, especially among funds, is a new thing and we don’t know how it will turn out.

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On top of that, NAV erosion could be a big deal for these funds, but especially to QDTE which distributes its income too often. In that case, you cannot keep all of your distributions. You may have to reinvest at least a portion of them to counter the risk of yield decline on your initial investment.