MSTY’s Covered Call Strategy Explained — And Why It’s So Risky

By deploying sophisticated options-trading strategies, the YieldMax MSTR Option Income Strategy ETF (NYSEARCA:MSTY) has produced substantial income from Microstrategy (NASDAQ:MSTR | MSTR Price Prediction) stock. Investors should at least have a basic understanding of how this exchange traded fund (ETF), the MSTY ETF, uses options to deliver its eye-catching yield.

It’s understandable if you’re tempted to load up on the YieldMax MSTR Option Income Strategy ETF and start collecting monthly paychecks. Don’t solely focus on the potential rewards, though. After learning about how the MSTY ETF works and why it’s risky, you can then take crucial steps to protect your wealth.

A Peek Into MSTY’s Strategies

Microstrategy stock doesn’t pay a dividend, but the YieldMax MSTR Option Income Strategy ETF features an annualized distribution rate (which is similar to an expected annual dividend yield) of around 80%. Not only that, but the MSTY ETF pays out its distributions on a monthly basis.

How is this possible? Since the YieldMax MSTR Option Income Strategy ETF holds U.S. Treasury bonds, some of its passive income will probably come from those bonds.

However, the YieldMax MSTR Option Income Strategy ETF is mainly known for producing income from Microstrategy stock. Interestingly, the MSTY ETF doesn’t directly hold MSTR shares.

Instead, the fund replicates the effect of holding Microstrategy shares with a synthetic options strategy. By trading a combination of MSTR call and put options, the YieldMax MSTR Option Income Strategy ETF indirectly provides exposure to Microstrategy stock without actually holding any MSTR shares.

Then, to generate income, the MSTY ETF writes (sells) covered call options on Microstrategy stock (or more precisely, on the synthetic option combinations that replicate MSTR stock). Sometimes, the fund might also purchase call options with a higher strike price; this is known as a covered call spread strategy, and it potentially generates income while limiting losses on the trade.

Why MSTY’s Strategies Are Risky

There are a number of risks associated with the YieldMax MSTR Option Income Strategy ETF. For one thing, the MSTY ETF automatically deducts 0.99% worth of annualized operating fees from the share price. This will drag down the fund’s price somewhat over time, so it’s an important consideration.

Second, the fund’s currently expected annual distribution rate of around 80% isn’t guaranteed to persist into the future. At any given moment, YieldMax can reduce the distribution rate of the MSTR Option Income Strategy ETF.

Perhaps the most consequential risk of the YieldMax MSTR Option Income Strategy ETF, however, is the limitations inherent to its options-trading strategies. Bear in mind, writing covered call options can generate income but will also tend to limit MSTY’s potential share-price upside if Microstrategy stock moves sharply higher.

A Major Limitation

As YieldMax explains, the MSTY fund’s strategies will limit its “participation in gains in the MSTR stock price beyond a certain point.” Even if Microstrategy stock shoots to the moon, the YieldMax MSTR Option Income Strategy ETF’s share price would only rise by a limited amount.

It’s also possible, in certain scenarios, that the YieldMax MSTR Option Income Strategy ETF can decline rapidly. Thus, the fund’s sizable and frequently paid distributions could be outweighed by its share-price limitations.

YieldMax summed up these risks succinctly with two warnings. First, the fund’s strategies “will cap its potential gains if MSTR shares increase in value.” Additionally, the MSTY ETF’s strategies are “subject to all potential losses if MSTR shares decrease in value,” and these losses “may not be offset by income received by the Fund.”

This explanation helps to account for the share-price loss of the YieldMax MSTR Option Income Strategy ETF during the past 12 months. During that same time frame, Microstrategy stock is up substantially — but then, MSTR stock didn’t pay out large monthly cash distributions like MSTY did.

Reduce Your Risk With MSTY

So now, you have a basic idea of how the YieldMax MSTR Option Income Strategy ETF derives income and why it’s risky. Still, it’s possible to invest in the MSTY ETF without unduly imperiling your portfolio.

If you would like to take a position in the YieldMax MSTR Option Income Strategy ETF, it’s wise to only purchase a small number of shares. With a tiny position size, you won’t demolish your account if the MSTY share price falls.

Then, you can enjoy any potential profits from the YieldMax MSTR Option Income Strategy ETF without losing sleep at night. Best of all, you’ll be a knowledgeable shareholder since you at least have a fundamental understanding of the ins and outs of MSTY.