HYBI ETF: A High-Yield, Low-Volatility Solution with Tax Efficiency

In a market where high-yield bond investors face rising interest rates and credit risks, the NEOS Enhanced Income Credit Select ETF (NASDAQ:HYBI) stands out as a structured alternative. By blending a quantitative bond allocation model with a tax-efficient options overlay, HYBI aims to deliver steady income while minimizing volatility. This article explores how its unique strategies create a compelling risk-adjusted return profile for income-focused investors.

The Quantitative Bond Allocation: A Rules-Based Approach to Risk Management

HYBI's core strategy leverages a proprietary quantitative model to dynamically allocate between high-yield and investment-grade bonds, as well as short-term Treasuries. The model evaluates three key factors:
1. Price trend: Assessing whether bonds are in an upward or downward trajectory.
2. Credit spreads: Monitoring the difference between high-yield and investment-grade yields.
3. Relative strength: Comparing performance against benchmarks like the Bloomberg U.S. Corporate High Yield Index.

This rules-based framework allows HYBI to shift exposures based on market conditions. For example, in 2022, when high-yield bonds fell 11%, HYBI's predecessor mutual fund declined just 2.3%, demonstrating its ability to reduce downside risk.

The Options Overlay: Generating Income with Tax Benefits

HYBI's secondary strategy involves writing S&P 500 put spreads to enhance returns. These spreads are constructed by selling a put option 5% out-of-the-money (OTM) and using part of the premium to buy a deeper-out-of-the-money put (8% OTM). This limits downside exposure to the 5–8% range while generating 2–2.5% annual income. The ultra-short duration of these options (rebalanced weekly) minimizes time decay risks.

Crucially, these options qualify as Section 1256 contracts, subject to a favorable 60/40 tax rate. This means 60% of gains are taxed as long-term capital gains (up to 20%), and 40% as short-term (up to 37%), regardless of holding period. For high-income investors, this reduces the tax drag compared to traditional bond income taxed as ordinary income.

Performance and Risk-Adjusted Returns: A Mixed Bag but Strategic Edge

Since its September 2024 launch, HYBI's NAV has returned 10.61% annualized, outperforming the High Yield Index's 15.74% over the same period—a counterintuitive result explained by HYBI's risk mitigation in volatile markets. However, recent data shows underperformance in less turbulent periods: as of March 2025, its 1-year NAV return was 3.33%, lagging the index's 6.44%.

This underscores HYBI's tactical focus: it excels in downturns but may trail in steady bull markets. Investors should view it as a complementary holding to core high-yield exposure, not a direct replacement.

Tax Efficiency: A Key Differentiator for Income Investors

The combination of bond income and Section 1256 options creates a dual tax advantage:
- Bond coupons are taxed as ordinary income, but their share of total distributions is offset by the options' favorable tax treatment.
- HYBI's 8.68% trailing 12-month yield (as of June 2025) includes both bond income and options premiums, with 27% of June's distribution classified as return of capital, reducing taxable income further.

For taxable accounts, this makes HYBI more efficient than traditional high-yield ETFs like iShares iBoxx $ High Yield Corp Bond ETF (HYG), which lacks the options overlay and has a higher expense ratio (0.48% vs. HYBI's 0.68% net).

Risks and Considerations

• Interest Rate Sensitivity: HYBI's bond exposure means it faces headwinds in rising rate environments. However, its short duration (average duration of 4 years) and tactical shifts may mitigate this risk.
• Credit Risk: High-yield bonds carry default risk, though the fund's focus on ETFs like USHY and SPHY spreads this exposure broadly.
• Post-2025 Expense Risks: HYBI's net expense ratio is capped at 0.68% until September 2025. Afterward, it may revert to the gross expense ratio of 0.73%, which is still competitive but worth monitoring.

Investment Advice: Position HYBI Strategically

HYBI is ideal for investors seeking:
1. Steady income with a tax-efficient structure.
2. Lower volatility compared to pure high-yield bonds.
3. Downside protection during market stress.

Avoid HYBI if:
- You prioritize maximizing yield in bull markets.
- You prefer passive, low-cost core exposure (e.g., HYG or JNK).

Final Thoughts

The HYBI ETF is a nuanced tool for income investors willing to trade some upside for stability. Its quantitative model and tax-smart options strategy make it a valuable addition to portfolios seeking to balance yield and risk. While its recent underperformance in calm markets is a drawback, its proven resilience in downturns and favorable tax treatment justify its place in conservative income strategies.

Investors should pair HYBI with broader high-yield ETFs and monitor its post-expiration expense ratio. For now, it remains a compelling option in an era of rising rates and market uncertainty.