USOY Is an Income Juggernaut

It distributes income to fund investors on a weekly basis

That combination of yield and payment frequency makes it appear to be an income juggernaut

However, and you bably know this is coming, there is a big catch: The fund has a very high-risk file

Here's a closer look at this ETF, which aims to vide investors with an enhanced oil-fueled income

Image source: Getty Images

Drilling down into the Defiance Oil Enhanced Options Income ETF USOY is an actively managed ETF that aims to vide investors with an oil-backed income through options

The fund's strategy is to sell put options on the oil ETF, the United States Oil Fund (USO -0

The United States Oil Fund is an exchange-traded security designed to track the daily price movements of crude oil dered to Cushing, Oklahoma (the country's main oil trading hub)

USO does that by in oil futures contracts and over-the-counter swaps (customized contracts between two parties, such as financial institutions and corporations)

The United States Oil Fund doesn't own physical oil, nor does it take dery of physical barrels at Cushing

It invests in futures contracts and swaps that it sells before expiration

It rolls the ceeds into new contracts that typically expire in less than two months

Crude oil futures contracts that expire in August

The Defiance Oil Enhanced Options Income ETF writes (shorts) put options on USO that are either at the money (right at the current price of the underlying security) or in the money (below the current market price)

This strategy aims to generate income and vide exposure to the price of USO

The ETF sells put options on USO at least once a week

Selling put options generates income if USO's price increases above the current price, stays flat, or decreases slightly (as long as the decline is less than the value of the options premium received)

The fund distributes the income it earns to investors each week

Drilling down into the fund's returns Writing put options can be a very lucrative income strategy

Options writers receive the premium (the value of the option) up front

They retain all or part of the premium, depending on the price of the underlying security at expiration

As big as that payout seems, it's down from prior payment levels

The fund, which had only recently started making weekly income distributions, had previously paid investors monthly

As the chart shows, the fund's income payments (and the value of the fund's price) have been steadily declining since its launch last year: USOY data by YCharts The decline in the fund's value is worth noting

That's due to two issues

First, the fund has a high expense ratio of 1

The costs of actively writing put options on USO are eating into the returns generated by the fund

The other issue is that USO's strategy aims to track the daily price movements of oil

While it does a solid job of tracking oil over the short term, it's abysmal at ing crude prices over the longer term

That's due to the costs of rolling futures contracts

The cost of writing put options on a security that steadily loses value hasn't been a winning strategy for the Defiance Oil Enhanced Options Income ETF

A high-risk income ETF The Defiance Oil Enhanced Options Income ETF seeks to der a high-yielding income generated by writing put options on a crude oil ETF

While the fund's weekly distributions are high relative to its price, that price has been steadily declining

That value erosion (due in part to its high expense ratio) has more than offset all the income generated by the fund since its inception

While the fund may perform better in the future, especially if oil prices are volatile to the upside, it's a very high-risk fund that's not suitable for investors seeking a bankable passive income

Matt DiLallo has no position in any of the stocks mentioned

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