Key Takeaways
- Derivative income ETFs are basically covered call strategies. People like derivative income ETFs because you can get much bigger yields and payouts from these derivative income funds.
- JPMorgan Equity Premium Income ETF, which we all call JEPI, is by far the most popular derivative income ETF. A lot of the big asset managers, like iShares, have derivative income ETFs, minus Vanguard. There are lesser-known ones like YieldMax.
- What we see is the yields range a lot because the risk you can take in these funds—it can go anywhere, and really, the trade-off is how much of your upside do you want to give up on a covered call strategy. The closer you set the strike price to the current price, the higher the premium you’re going to get, but that’s because it’s more likely to go above that strike price, and you give up the upside.
- One of the big questions an investor should ask his or her advisor before investing in one of these ETFs is about opportunity cost.
- Derivative income ETFs’ income should probably go down when interest rates fall.
- When it comes to derivative income ETFs, around 30 basis points is a pretty good deal.
- Two really large derivative income ETFs that hold the majority of the assets in this category are JPMorgan Equity Premium Income, which is JEPI, and then JPMorgan Nasdaq Equity Premium Income, which is JEPQ.
- Before jumping in to derivative income ETFs, you want to know how much risk you’re taking, and usually a good proxy is how big is the yield.
Susan Dziubinski: I’m Susan Dziubinski with Morningstar. Derivative income ETFs have been raking in the assets in 2025, gaining traction with advisors and iacnvestors alike. But what are derivative income ETFs? How do they contribute to a portfolio? And what are the key questions investors should be asking about them before investing? Joining me to answer these questions and more is Jason Kephart. Jason is a senior principal with Morningstar’s multi-strategy asset ratings team.
Jason Kephart: Good to see you.
What Are Derivative Income ETFs?
Dziubinski: All right, let’s start at the beginning. What are derivative income ETFs, and how do they work?
Kephart: Yeah, so they’re basically covered call strategies, and what that means is they basically own a portfolio of stocks, and they’ll sell call options on top of those stocks or on top of an index like the S&P 500, and when you sell a call, you get a premium for doing so, so that’s where the income’s coming from. The trade-off is you’re giving up the upside of the stock portfolio. So, you can have a stock, say Apple. Let’s pretend it’s trading at $100 a share. You could sell a call at $120, collect a premium for that, call it five bucks, and as long as Apple’s price stays below $120, you get to keep the stock and keep your $5, but if it goes above $120, you don’t get the benefit of that gain. That goes to the owner of the call option.
How Do Derivative Income ETFs Work in a Portfolio?
Dziubinski: So then, why would an advisor recommend that a client invest in a derivative income ETF? You know, what role can these investments play in a portfolio?
Kephart: It really comes down to income. People love income. They love seeing big yields and these funds deliver that in a way that your classic dividend ETFs really can’t match, just because they don’t have that kind of inherent leverage of the call options, which lets you really set how much income you’re getting and so you can get much bigger yields and payouts from these derivative income funds.
Popular Derivative Income ETFs
Dziubinski: So now, JPMorgan Equity Premium Income ETF, which we all call JEPI, is by far the most popular derivative income ETF, but there are other asset managers in this space besides JP Morgan. What are some of the more familiar names or the more popular names when it comes to derivative income ETFs?
Kephart: Yeah, I think when you think about ETFs, a lot of the big players are in there, minus Vanguard. This is probably a little too spicy for what Vanguard’s used to. But iShares just launched one with the ticker BALI, which I’d love to take a vacation. I don’t know, we haven’t rated the ETF yet, though, so we’ll talk about that another day. But also State Street, they have a very popular lineup of sector ETFs, and they basically just JEPI-ed those, so you can get derivative income from an energy sector ETF or a tech sector or utilities, and like kind of doubling down on income there. So, I think we’re seeing all the major ETF firms you’d expect to be in this space, and then some lesser-known ones like YieldMax, which we’ll probably talk about a little later.
Best Strategies for Derivative Income ETFs
Dziubinski: You mentioned the yields, so I went into Morningstar Direct, and I just downloaded the entire category, the derivative income ETF category, and I saw everything from yields ranging from zero to 33% for 12-month yield and then total returns were from like negative 26% to positive 26%, so clearly there are a lot of different strategies included in this sort of bucket or this category. So, talk about a few strategies that Morningstar thinks have the most merit.
Kephart: Yeah, well, I think JEPI’s one that we think is done in a reasonable manner. They just do selling call options, but I think the way you can get in trouble is when you get really kind of too cute. You can sell put options—those are kind of a contract to that do better when a stock price falls, so if you think the stock’s going to go up, you could sell a put instead of a call, but when the stock falls, your losses are kind of like, you can be in a lot of trouble then. So what we see is the yields range a lot because the risk you can take in these funds—it can go anywhere, and really, the trade-off is how much of your upside do you want to give up on a covered call strategy. The closer you set the strike price to the current price, the higher the premium you’re going to get, but that’s because it’s more likely to go above that strike price, and you give up the upside.
Ask Your Advisor These Questions Before Investing in Derivative Income ETFs
Dziubinski: So then, two questions, obviously, that an investor should ask his or her advisor before investing in one of these ETFs is what role it would play in the portfolio and then how the strategy works since they can be kind of all over the place. So then, talk a little bit, Jason, about the risks of derivative income ETFs. What are they?
Kephart: Yeah, one of the big ones is opportunity cost. Like we said, you’re giving away the upside of the stock portfolio, and what we know about stocks is they generally go up. So, over long-term periods where you’d expect stocks to have a positive return, these funds are probably going to trail the total returns of something simple like the S&P 500. So, that’s the main thing I would think is the risk you should be aware of heading in because that’s the one that’s most likely going to play out.
Now, with covered call strategies in general, there’s not like as much of a blowup risk, but with options, you can get really creative in ways that maybe can lead to a lot more drawdown risk, and that’s something I would be very careful of when trying to figure out why are these derivative income ETFs yielding so much money. YieldMax is a really interesting example. They actually do option strategies around single stocks. So, they have a $5 billion ETF around Strategy, the bitcoin treasury company. So, that 12-month yield is like over 100%. I think when you’re looking at something like that, although the yields may look very attractive—I would love 100% yield …
Dziubinski: Right, right.
Kephart: … you really need to think about what goes into that and really think about are you getting a good trade-off here.
How Derivative Income ETFs Perform When Interest Rates Fall
Dziubinski: The yield is a good indicator of risk, obviously. Now given where we are with interest rates today, Jason, and again, there is talk that the Fed will very likely, as we’re taping this, cut one or two times this year. So let’s say we’re moving into an environment where interest rates are going to go down a little bit. Do derivative income ETFs do better or worse in that type of environment?
Kephart: The income should probably go down. The income is a component to the pricing of the options, so lower interest rates in general should mean lower premiums. You would expect the yields to come down, though I think they’ll still be comfortably ahead of your classic dividend ETFs, so there might still be some attractiveness there if you’re just really into income. And we would stress—total return is what we should really focus on. But I think some people just really love that safety net of, “I’m not pulling down my capital. I’m getting income delivered to me.”
What Cost Should Investors Look for When Investing in Derivative Income Funds?
Dziubinski: Right, right. Now, of course, investors should always ask their advisors about the cost of an investment with anything they’re investing in. So when it comes to derivative income ETFs, is there a ballpark? Is there something that Morningstar would say, “That’s reasonable for what the product is supposed to be providing an investor”?
Kephart: Yeah, I think since most of these are being launched in ETF form, we are seeing fees be fairly competitive. JEPI is around 30 bps—30 basis points. And so, that’s high compared to the S&P 500, which you get for 5. But I think in the grand scheme of things, 30 basis points for an investment strategy is a pretty good deal. I think if we were getting that for most strategies like 10 years ago, people would have been over the moon. So I don’t think the costs are prohibitive. But it’s just still something to be mindful of, and I’m sure there are some out there that do have fees that are a bit higher than you’d like.
JEPI vs. JEPQ
Dziubinski: OK, so Jason, we talked about how there are, of course, other asset managers that offer derivative income ETFs, but the two really large derivative income ETFs that hold the majority of the assets in this category are from JP Morgan. JPMorgan Equity Premium Income, which is JEPI, and then JPMorgan Nasdaq Equity Premium Income, which is JEPQ. So talk a little bit about what Morningstar thinks of both of them from a rating perspective and how they differ from each other.
Kephart: JEPI has a Morningstar Medalist Rating of Bronze. And we like that fund because I think the portfolio is very similar like the S&P 500. There’s some stock-picking going on, but that’s not really what’s going to drive returns. And they’re doing covered calls on top of that in, I think, a very reasonable way. Hamilton Reiner, the kind of mastermind behind JPMorgan’s options suite, is someone we know pretty well from JPMorgan Hedged Equity Fund we’ve covered for a long time. And we think they take a really reasonable approach to doing it. They don’t take excess risk.
Read Morningstar’s full report on JEPI.
JEPQ is very similar, but instead of like an S&P 500 starting point, it’s the Nasdaq. So tech stocks are just more volatile naturally, so more volatility means you can sell the call options at a higher premium. And the idea being that if there’s more volatility, the strike prices are more likely to hit, so they’re worth more. But I think there with Nasdaq, you’re really investing in tech stocks for growth, so I think where we kind of had a little bit of a pause there and why that one has a Morningstar Medalist Rating of Neutral is the idea behind giving up the upside in tech stocks to reap income. And if we get another long tech drawdown, maybe AI earnings start to disappoint, maybe you could see JEPQ have a really good run. But I think in general, we think that you should be investing in these growth companies for the growth, not really leveraging them into a kind of income stream.
Read Morningstar’s full report on JEPQ.
Key Takeaways
Dziubinski: So let’s wrap up with a couple of key takeaways from you, Jason. Who might these derivative income ETFs be good for, and what would an investor really need to know before jumping in?
Kephart: Yeah, I think you want to know how much risk they’re taking and usually a good proxy is how big is the yield? If you see really high yields, that probably means there’s a bit more risk baked in. But also who are they good for? I think it’s the investors who really get some peace of mind from that income stream from the portfolio. And it’s one of those things where if it’s going to help you stay invested and help you feel better about your portfolio, then maybe the opportunity cost of not keeping up with the broader stock market in a bull market, maybe that’s OK. I think those are the people that I would think these are probably most geared toward.
Dziubinski: Perfect. Well, thanks for your time today, Jason. It’s good to see you.
Kephart: Thanks for having me.
Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.
Watch 3 Liquid Alternative Funds That Bring the Defense for more from Jason Kephart.