SLVO ETN: 18% Imaginary Yield, But You Can Do Better

There is no shortage of covered call funds. It seems a new one pops up every single day. 2023 has seen an explosion in single stock covered call funds like YieldMax NVDA Option Income Strategy ETF (NVDY) as the yield-chasing exercise reaches new heights. Our job is to separate the wheat from the chaff and try and help investors decide if a fund will give them the right income while improving their beta and adding some alpha. Our talking point for today is something that might make sense intuitively, covered calls on Silver. Silver is a volatile asset, and covered calls on it can take advantage of the high implied volatility.

The Credit Suisse X-Links™ Silver Shares Covered Call ETN

The Credit Suisse X-Links™ Silver Shares Covered Call ETN (NASDAQ:SLVO) (exchange traded notes) are senior, unsecured debt securities issued by Credit Suisse AG. As everyone who has remotely followed the capital markets knows, Credit Suisse had a shotgun marriage to UBS Group AG (UBS), and that has improved the credit profile of these notes. But that is the first thing to keep in mind while looking at ETNs as they are not the same as ETFs and have asymmetrical downside risks. At best, they will trade at NAV, even if the underlying issuer magically gets rated AAA. At worst, you can get wiped out even if the underlying security performs like a meme stock. With that start point, let us look at how they are making money for you.

The return of this ETN is linked to the Credit Suisse NASDAQ Silver FLOWS™ 106 Index. The ETN is designed to maintain a notional long position in iShares Silver Trust ETF (SLV) and then sells notional calls on that notional position. The monthly variable cash coupon is based on the option premiums received from selling call options, which are about 6% out of the money.

If all of this sounds like an incredible “notional” exercise, then well, it is. Rather than invest that money directly, Credit Suisse is basically riding on notional positions that are going to replicate the returns of this strategy. To the extent Credit Suisse can do this at a cost less than their cost of capital, it turns into a winning strategy for the company.

How Does This Work For You?

The strategy is essentially a blind (no regard to fundamentals) but rules-based (6% out of the money calls) run. We have been hypercritical of blind covered call strategies that tend to get the worst possible results of underperforming in bull markets and not outperforming significantly in bear markets. Before we look at SLVO’s performance, let us show you one other covered call fund that we have written about, Nuveen NASDAQ 100 Dynamic Overwrite Total Return Fund (QQQX). Here is the performance in the 2007-2009 bear market versus Invesco QQQ Trust (QQQ).

Pretty shoddy right? There is almost no outperformance to speak of. We show you this so that you understand that this is a feature and not a bug of covered call funds. All of them tend to do this when they use rules-based option selling. SLVO is no different. See the total return tracking profile below, which includes those hefty dividends that you get. SLVO lags SLV from the start point in late 2013, (where Silver was in a bear market) right into the COVID-19 lows.

The lag was bad but not too bad. Nonetheless, this was a defensive investment, at least one would think that based on the concept of covered calls and yet it failed. Right from COVID-19 lows, it took that underperformance to a whole new level. Since inception, you have the privilege of lagging SLV by exactly 32% as we write this. We might add here that post COVID-19 lows, the implied volatilities on SLV option premiums skyrocketed. You could get a lot for out-of-the-money options. Even then, SLVO lagged badly.

Outlook & Verdict

We have been one of the rare US Dollar bulls over the last two years:

The US dollar index is primarily an Anti-Euro index. In this race, we have an inebriated runner (US Dollar) and an inebriated runner shot twice with bear tranquillizer (Euro). Guess which one we have put our money on?

Source: 3 Reasons To Revisit

We still like the US Dollar relative to its counterparts. The housing bubble outside of the US is far worse, and we think the bullish move in the US Dollar still has room to run despite the possibility of a shorter-term pullback.

So far we have been hesitant grabbing Silver and generally told investors to not fear fictional short-squeezes. At some point, though, we see Silver and the US Dollar going up together. We would look to accumulate Silver as it went lower. That said, SLVO is the last vehicle we would use for that. The expense ratio of 0.65% does not really bother us. But what does bother us is the strategy that produces poor returns in the best of times and in the worst of times. Those investors looking to generate income from SLV or Silver, their best bet is to buy the ETF and sell a covered call on it 15 months out. Depending on the strike, you can generate 10-15% income on it. This method of using a longer duration option handily outperforms the whipsawing you get with shorter-dated options. We showed this at work in our answer to Global X Russell 2000 Covered Call ETF’s (RYLD) call selling over here. SLVO is best avoided as it is a blend of poor strategy coupled with a stealth extra dose of credit risk.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.