Is the Fidelity Yield Enhanced Equity ETF's Promise Too Good to Ignore? Understanding the Risks of This Fidelity Options Income ETF

The Fidelity Yield Enhanced Equity ETF (NYSEMKT: FYEE) is a relatively new exchange-traded fund (ETF). Based on the ETF's fourth-quarter 2024 dividend of $0.508 per share, it has an annualized dividend yield of over 7%. Given the S&P 500 index's (SNPINDEX: ^GSPC) tiny 1.2% yield today, the Fidelity Yield Enhanced Equity ETF will probably interest high-yield investors. Before you buy it, however, you need to understand what you are buying.

What does the Fidelity Yield Enhanced Equity ETF do?

Exchange-traded funds have changed over the years. When they were first introduced they religiously tracked indexes. But there are only so many major indexes to track, so ETF sponsors started to create new indexes. Some of those indexes were refined versions of the major indexes, some were simply created out of thin air. And then ETF sponsors started to offer actively managed ETF products.

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That's, basically, what the Fidelity Yield Enhanced Equity ETF is -- an actively managed ETF. According to Fidelity, it is "using computer-aided, quantitative analysis of historical valuation, growth, profitability, and other factors to select a broadly diversified group of stocks that may have the potential to provide a higher total return than that of the S&P 500 Index." Nowhere in there does it say that the fund is tracking an index or that the selection process is farmed out to a third party.

After creating a portfolio, the managers are "employing a disciplined options-based strategy designed to provide income." That includes "selling (writing) call options on a large cap equity index, such as the S&P 500 Index." Again, this is basically a process driven by fund managers, not an outside index provider.

The human touch isn't bad, but...

To be completely fair, there's absolutely nothing wrong with an ETF that is actively managed. In fact, some investors might prefer actively managed ETFs over index-based fare. However, there are some factors that investors need to consider before buying Fidelity Yield Enhanced Equity ETF. One of the biggest is the yield.

Selling options is a good way to generate income, but there are caveats. For starters, it can limit upside potential so investors shouldn't look at this ETF and think it will provide both a large income stream and robust capital appreciation. That just isn't how most options income approaches end up working over the long term. It is hard to keep throwing off a huge income stream -- like the ETF's well above-market 7% yield -- while also generating large capital gains.

There's also the issue of income volatility, since selling options as the ETF does isn't likely to lead to a consistent income stream. The Fidelity Yield Enhanced Equity ETF has only paid three quarterly dividends so far and each one has been larger than the last, but it would be a mistake to think that this trend will continue indefinitely.

FYEE data by YCharts

A second big issue to consider is stock selection. The top 10 holdings in the ETF make up around 38% of the portfolio. And the names on the list read like a who's who of hot stocks, including technology giants Apple, Nvidia, Microsoft, Amazon, and Meta Platforms. In fact, those are the top five holdings, in order. It is wonderful that the ETF uses a "computer-aided" system to pick the best options strategies related to these stocks, but it's important to remember that by focusing on top S&P 500 stocks, the managers also appear to be just be following the crowd in terms of stock selection.

If market trends shift quickly, the Fidelity Yield Enhanced Equity ETF could end up holding the wrong stocks at the wrong time. In fairness, as an actively managed ETF, the fund would have the leeway to change the portfolio more quickly than an index-based ETF. But even that might not work to shareholders' benefit if emotional decisions result in swift portfolio overhauls that lead the ETF to miss out on long-term opportunities. Investing is hard and index investing does offer some benefits over human-based decision making.

You are buying the yield, but it could be riskier than you think

The real selling point with the Fidelity Yield Enhanced Equity ETF is a lofty income stream. That's fine, but investors need to understand that it isn't going to be a consistent income stream. And there's a very good chance that the income investors collect will fall at some point. Moreover, given the nature of selling options, the income this ETF generates is likely to account for most of the ETF's returns over time. Its unit price has risen quickly out of the gate, but it is probably a mistake to read too much into that given the very short history here. Big income and low share price gains might be OK with you, but it is still something to consider if you have a long investment horizon. All in, the Fidelity Yield Enhanced Equity ETF is an interesting new addition to the ETF world, but investors should tread with caution until the managers have proven they can provide consistent and attractive results.

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Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Apple, Meta Platforms, Microsoft, and Nvidia. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.