YBIT Is an Income Juggernaut

But is it a worthwhile investment

It does that by constantly writing covered calls on its own "synthetic long" positions in Bitcoin, and it currently pays an annual distribution rate -- or the yield an investor would receive if its most recent distribution (including option income) stays the same for the full year -- of 41

That massive yield makes YBIT an income juggernaut, but is it really just a high-yield trap

Let's dig deeper and see how YBIT actually churns out its distributions

Image source: Getty Images

Why does YBIT create "synthetic" Bitcoin positions

To understand why YBIT creates synthetic long positions in Bitcoin, we should discuss how covered calls work

A covered call is an option that lets an investor earn a premium by agreeing to sell an underlying security if it reaches a certain price by a certain date

If that security doesn't hit that strike price before the expiration date, the call expires, and the investor keeps the premium

If it reaches the strike price, the investor keeps the premium but must sell the underlying security

Many investors sell covered calls on their own stocks to generate extra income

More volatile investments net higher premiums, since there's a higher chance they'll hit their strike prices

That's why Bitcoin's high volatility makes it an ideal candidate for writing covered calls

However, an investor who directly holds Bitcoin in a digital wallet can't write covered calls on that position in the same way as stocks or exchange-traded funds (ETFs), because there's no way to verify and collateralize your Bitcoin holdings for the options market

Therefore, the closest alternative is to buy a Bitcoin ETF to write covered calls

Yet YBIT also doesn't directly buy Bitcoin ETFs because it would tie up a lot of its cash and isn't tax-efficient

Instead, it simultaneously buys calls and sells puts on the is Bitcoin Trust (IBIT -0. 30%) to build a "synthetic long" position in the ETF with less cash

It then writes covered calls on that synthetic position in IBIT to churn out options income, which could be comparable to writing calls on the ETF, and it usually parks the rest of its cash in U

T-bills to earn interest and support its future options trades

But does this strategy make sense

Covered call strategies work best when the underlying security trades sideways, since it can generate consistent income but won't rise enough to be called away

Letting YBIT automate the covered calls cess with its synthetic stake in IBIT is also a lot simpler, cheaper, and more tax-efficient than manually writing covered calls on Bitcoin ETFs

It also gives you some conservative exposure to Bitcoin: Even though the covered calls will limit your upside potential, its big distributions could also tect you from any steep declines

That said, YBIT's complicated strategy of writing options on top of other options could result in unstable returns in volatile

Therefore, YBIT was merely returning its investors' cash as distributions while adding a single-digit percentage through its covered call options

That percentage was further reduced by its high gross expense ratio of 0

That fee might be worth it if YBIT dered impressive market-beating gains

That slightly beat the S&P 500's total return of 13% -- but it's unimpressive for a speculative "high-yield" ETF

Investors should avoid this income juggernaut YBIT might seem an interesting way to churn out some extra income from Bitcoin's volatile swings, but it's not a great investment

If you want some exposure to Bitcoin, it's smarter to simply buy the cryptocurrency or a spot price ETF

If you want some extra income, it might be smarter to invest in a traditional dividend-oriented ETF instead of one that charges high fees, uses complicated options strategies, and funds most of its distributions with its investors' own cash

Leo Sun has no position in any of the stocks mentioned

The Motley Fool has positions in and recommends Bitcoin

The Motley Fool has a disclosure policy.