NEOS Investments recently launched the NEOS Nasdaq-100 Hedged Equity Income ETF (NUSI ) after making several changes to the underlying strategy. The fund, previously a Nationwide ETF sub-advised by NEOS, now boasts a different risk profile with changes to the options strategy. I sat down with Troy Cates, co-founder and co-PM at NEOS Investments, to dive into NUSI’s changes.
Potential Option Strategy Enhancements for NUSI
Gordon: Troy, always a pleasure. I know NEOS previously sub-advised NUSI, but now it’s in-house and you’ve made a number of alterations to the strategy. Can you step through those changes?
Cates: NUSI is one of only a few NASDAQ-100 hedged equity ETFs. I’m hoping we can really gather some interest, because the S&P 500 hedged equity ETFs have definitely drawn interest, and most of those aren’t paying income. I think people are looking for income but want a measure of downside protection and to capture a good portion of the upside when the Nasdaq-100 actually moves.
What current investors in NUSI are used to is a long NASDAQ-100 equity portfolio, and that’s staying the same. What’s changing is the active option strategy on top of it, going from a net credit collar to a put spread collar. We’re still going to be selling a call and bringing in income to distribute to shareholders. But, instead of just buying a long put for downside protection, we’re switching to a put spread. That means we purchase a protective put and then sell another put option far out of the money. It’s intended to provide more meaningful downside protection closer to the current price of the Nasdaq-100 Index, and enhance the Fund’s overall total return.
The Difference Roll Timing Makes
Cates: One of the big things we’re changing is how the options roll and when they roll. The old product used to roll from the day before option X free, which is the third Friday of the month. We would roll it on that Thursday, with the duration out one month expiry, then we’d roll it again the next month.
The new strategy is very similar to our other equity products, where we’re rolling at month’s end. The duration is a little longer than that one month, about seven weeks or so to that third Friday expiry. To give you an example, in November we rolled the product on the last day of the month, so the 29th. The options went out about seven weeks to January 17 for the expiration. We’ll close those options at the end of December, with a couple of weeks left before they would have expired. With some duration left on the options contracts, we’re aiming to limit the possibility for rapid price decay into expiration. In this case, we’d expect the puts to still have some level of intrinsic value during each roll period.
We’ve noticed we can capture more of the premium we want by not sitting there waiting for things to either decay down or getting too close to expiry that you’re shifting and moving so much with the market. We’re still bringing in that income. However, instead of spending a lot of it on one long put that goes to zero, we’re selling some of that protection further away.
The Reasoning Behind the Changes
Gordon: Can you go a bit more in-depth into the decision to use a put spread collar and how you’re positioning the puts?
Cates: The idea is two-fold. One, we’re trying to buy puts a little closer to the money to provide more meaningful downside protection. The old model would toggle between buying puts closer to the money, depending on where volatility was, or buying very far out-of-the-money puts. Some months, if we had a sell off, the far out-of-the-money position wouldn’t offer any protection.
Two, as we did our modeling — outside of something like COVID-19, which is obviously a very rare scenario in the market — we more commonly see drawdowns of 5%–10% on a monthly basis. Rather than hedging all the way down to zero, because if we hit those levels there’d be much bigger problems, we’re selling away some of the lower end insurance via a short put, with the goal of financing a more meaningful long put each month.
The call model doesn’t need to write on 100% of the notional, but the put side is always 100% of the notional. For example, the call side in November was 75%. If markets started moving higher, NUSI would capture more of the upside, because 25% of the portfolio remained uncapped. We’re trying to capture more of the upside and give you a more meaningful measure of downside protection.
In a month where markets are down marginally, it’s really going to be about how much income do we bring on the short call now? But if markets are down, say 15%, maybe NUSI is down 3% or 4%. And then if markets bounce, we should still participate with a lot of the upside of the Nasdaq.
A Look Back at the Challenges of 2022
Gordon: NUSI previously offered downside protection if markets fell somewhere between 7–10% in a month. In the slow declines of 2022, the strategy offered few protections. Can you talk about talk about the hurdles of 2022?
Cates: The challenges for NUSI in 2022 were two-fold. NUSI had this option strategy that went from mid-month to mid-month, but no one looks at performance mid-month, only calendar month. So that’s one thing we’re fixing, and we incidentally get better return performance by managing it that way.
Second, there was a mechanism where you could close the calls if the market ran up enough and hit certain levels of volatility. Because of how quickly the market ran up at the end of ‘21 into New Years, the calls were triggered to close. And then the market sold off really quickly.
For example, if we had a long put purchased mid-month at roughly five or six percent out of the money, and the market rallied three or four percent, then at month-end your put is closer to 10% out-of-the-money. There were a few incidences of sharp selloffs during the early parts of some months where we unfortunately absorbed all of the losses until the new option positions were reset mid-month.
NUSI was challenged during the first six months of 2022, experiencing scenarios like the one I just described. However, the Fund performed better during the second-half of 2022. Over the past two years, as of the end of December 2024, NUSI delivered a total return of 65.23%. It also delivered reliable monthly income for five years running, which we’re really proud of.
Where Does the Revamped Strategy Fit in Portfolios?
Gordon: Given its income potential and volatility reduction, how do you see advisors using NUSI in their portfolios?
Cates: We’ve talked to people that lowered a bit of their exposure to the Nasdaq-100. They maintain exposure to the Nasdaq-100 with NUSI, but with added income potential and lower volatility. So, we’ve seen it as a substitution even though that’s not what it’s fully built for because they aren’t going to get the full upside when the Nasdaq-100 experiences a strong rally.
It’s really about income. We’ve had more people start to look at portfolios not as a 60/40 but more a 50/30/20, where the 20 is alternatives. They put their income-producing strategies in the alternatives, along with things like crypto, real estate, or whatever else they’re using.
For the advisors that still own it, we’ve talked to them about the updates to the strategy and they’re really excited about it. I think some advisors owned it in the past and felt like it didn’t do what it was supposed to. We want those advisors to take a look again. We pride ourselves on being available to talk through NUSI or any of our other strategies.
Combining NUSI and QQQI In Portfolios
Gordon: Advisors and investors familiar with NEOS know that you also offer the NEOS Nasdaq 100 High Income ETF (QQQI ). That fund invests in the Nasdaq-100 but uses covered calls to generate income. Do these two funds complement each other in a portfolio? How are you thinking about where they slot into a portfolio?
Cates: I can see NUSI and QQQI complementing each other. If you want Nasdaq-100 exposure and want a portion of your portfolio to be a little safer, a little less volatile, then NUSI makes sense. With QQQI, you’re generating a lot more income. However, you’re going to take on more risk.
NUSI is more of a hedged equity product. We’re trying to give you a measure of downside protection overall and lower your volatility. You’re not taking as much equity risk like you are with QQQI. You may not get that huge distribution, but you still will get a strong distribution on a monthly basis. It’s for someone who wants to be involved in the Nasdaq-100 but wants to have a little bit of protection on the downside, and monthly income. From a tax-efficiency perspective, we’re managing the funds similarly with index options.
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