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Like many other risky asset classes, Ethereum (CRYPTO: ETH) got off to a rough start until 2022. Currently, the second largest cryptocurrency by market capitalization is trading in the $ 2,500 range, down significantly from the 52-week high of $ 4,891.
However, if you can reduce volatility, the current low prices can be a great buying opportunity. Large fluctuations in Ethereum tend to benefit swing traders. However, with the new ETFs, you can get high yields from high volatility by selling covered calls.
How Do ETFs Work?
Purpose Ethereum Yield ETF (TSX: ETHY.B) is a covered call ETF. This is an option strategy in which the call option seller (ETF manager) owns the same amount as the underlying asset Ethereum.
ETFs hold a long position on the underlying Ethereum and sell the right to someone else to buy it at a higher price (strike). This is valid until a specific date (expiration date). To that end, ETFs earn a cash premium.
In general, the higher the volatility of the underlying asset, the higher the premium. In this case, Ethereum is so volatile that ETHY can get a big premium by writing a call. After that, this will be paid monthly as an ETF yield.
ETHY can be held by TFSA / RRSP, but Ethereum cannot. However, the management cost ratio (MER) is 1.10%. The annual dividend yield is very high at 18.18%, which is higher than the preferred stock.
However, yields can fluctuate. In general, the higher the Ethereum stock price fluctuates and the higher the yield. Yields can drop during periods of low volatility, such as after a crash.
What are the risks?
Covered call ETFs like ETHY have the same drawbacks as holding real assets. In this case, if Ethereum is a tank, the value of ETHY will be the same. However, ETHY only participates in some of the benefits of Ethereum.
When the price of Ethereum soars, ETHY will have a relatively poor performance. If the price of Ethereum is higher than the strike price of the sold call, the call buyer “exercises” the option to buy ETHY at the lower strike price.
This means that ETFs must sell ETHY at strike prices, even though they can get better prices on the market. This allows ETHY to miss profits and limit your returns on good days. If the price rises significantly, even the premiums received cannot make up for the lost profits.
Overall, the risk-return relationship is not good. You will feel the full impact of the crash while missing out on the full range of profits from the expanding bull market. This is an example of an asymmetric bet that we generally want to avoid.
Who is this ETF suitable for?
Covered call ETFs are usually avoided as they have unlimited downside risk (underlying assets can be $ 0) and upsides are limited by the strike price. This will result in poor performance in the bull market.
There is no free lunch at an ETF like ETHY — you are simply selling future profits for an immediate premium. In the long run, regular Ethereum will significantly outperform, especially with the momentum and volatility we’ve seen before.
ETHY is suitable for income-oriented investors who are looking for high yields for some reason. This niche could be FIRE people who want to live by distribution rather than selling stock.
Another use case is when the crypto market is trading sideways for a long period of time. Being able to fix high cost yields when Ethereum prices are low helps the portfolio to make a profit even under these conditions.
