Shifts in Interest Rates May Bring Back Dividend Stocks for Investors

In 2022 and 2023, rising interest rates drove many income investors from dividend stocks toward low-risk CDs, T-bills, and bonds. Many dividend-paying stocks and exchange-traded funds (ETFs) lost their appeal during this time.

However, in 2024, the Federal Reserve reduced its benchmark rates three times. Plans for at least two more rate cuts in 2025 could encourage income investors to gradually return to higher-yielding dividend stocks and ETFs.

Start Your Mornings Smarter! Wake up with Breakfast news in your inbox every market day. Sign Up For Free »

Image source: Getty Images.

But this shift will take time. With the 10-year Treasury yield near 4.8%, many fixed-income investments still offer better returns than most dividend stocks. As a result, instead of rapidly buying individual dividend stocks now, investors may find it wiser to consider a diversified, income-oriented ETF that utilizes covered calls to enhance its yield.

For those interested, the JPMorgan Nasdaq Equity Premium Income ETF (NASDAQ: JEPQ) might be worth a closer examination. A modest investment of $500 in this ETF can yield nearly $50 in additional income annually.

Understanding Covered Call ETFs

A covered call involves writing a call option on a stock an investor already owns. By selling this call, the investor earns a premium, while the buyer receives the option to purchase the stock at a specified price by a set date. If the stock fails to reach that price, the investor keeps both the premium and the stock. Conversely, if the stock exceeds the strike price, the investor must sell it at that predetermined price.

For example, if an investor purchases 100 shares of Apple at $100, they might be willing to sell the shares at $250. If Apple’s current price is $230, the investor could write a covered call with a strike price of $250 that expires on January 31. This option currently has a premium of $0.94, resulting in a total premium of $94.00 for the contract (excluding commissions and fees). If Apple’s price remains below $250 by January 31, the option will expire, and the investor retains the $94. Should the stock rise to $260, the investor must sell at the $250 price point.

This strategy tends to work well in stagnant markets. However, in a bull market, gains may be limited as rising stocks can be sold away. Still, many investors successfully use this approach to enhance their income.

Since consistently selling covered calls can be cumbersome, many financial firms now offer ETFs that automatically execute covered calls on diversified groups of stocks, generating stable income. This results in higher yields compared to traditional dividend-focused ETFs.

Source: YCharts

The Case for JPMorgan Nasdaq Equity Premium Income ETF

The JPMorgan Nasdaq Equity Premium Income ETF features 103 stocks that closely track the Nasdaq-100 index. It writes covered calls on the Nasdaq-100 monthly and pays distributions each month. With a current 30-day SEC yield of 9.76% and a low expense ratio of 0.35%, it is an attractive option for income seekers.

This ETF uses equity-linked notes (ELNs) connected to covered calls, making them more tax-efficient than standard covered calls, which face short-term capital gains taxes with each trade.

With a focus on the Nasdaq-100, this ETF keeps itself diversified. Its leading positions include Apple, Nvidia, Microsoft, and Amazon. Presently, it trades at $55.50, slightly below its latest net asset value (NAV) of $55.95, meaning investors can acquire the underlying stocks at a modest discount.

High yield results from covered calls on more volatile stocks, which bring in larger premiums than those of more stable ones. The volatility in the Nasdaq-100 over recent years has contributed to this dynamic. Diversification helps balance this volatility while concentrating on generating consistent monthly distributions rather than chasing the highest premiums.

These features render the JPMorgan Nasdaq Equity Premium Income ETF a reliable means of earning close to a 10% yield in a fluctuating market. While it may not be ideal for growth investors, it offers a solid opportunity for those seeking steady income as the market moves sideways.

Is Now the Right Time to Invest $1,000 in JPMorgan Nasdaq Equity Premium Income ETF?

Before investing in the JPMorgan Nasdaq Equity Premium Income ETF, keep the following in mind:

The Motley Fool Stock Advisor analyst team has identified their top 10 best stocks for investors, and surprisingly, the JPMorgan Nasdaq Equity Premium Income ETF is not on that list. The stocks chosen have great potential for significant returns over the coming years.

Consider this: back on April 15, 2005, Nvidia was featured on this list. If you had invested $1,000 then, it would be worth $807,495 today!*

Stock Advisor offers a straightforward pathway to financial success, complete with tailored portfolio guidance, regular updates from experts, and two new stock recommendations each month. Since its inception in 2002, this service has exceeded the S&P 500’s returns by more than four times.*

See the 10 stocks »

*Stock Advisor returns as of January 13, 2025

John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, serves on The Motley Fool’s board of directors. Leo Sun holds positions in Amazon, Apple, and JPMorgan Nasdaq Equity Premium Income ETF. The Motley Fool invests in and recommends Amazon, Apple, Microsoft, and Nvidia. Additionally, the Motley Fool advises options related to Microsoft. More details about the Motley Fool’s disclosure policy are available.

The views and opinions expressed herein are those of the author and do not necessarily reflect the opinions of Nasdaq, Inc.