Investors who are concerned about stock market declineAnd those who don’t mind limiting potential upside gains can consider a new breed of exchange-traded funds called outcome-specific ETFs.
Funds, also called stock exchange ETFs, use options to mitigate losses in exchange for limiting some gains, creating protection bars over the investor’s return. Since its emergence about four years ago, the funds had total assets of about $13.6 billion as of mid-July and had acquired $5.4 billion in 2022, according to Bloomberg data provided by Innovator ETFs.
ETFs protect against a predetermined amount of losses. Most of them put loss protection at about the first 10%, 15% or 30% of the downside in the market and are designed to hold for a full 12 months, although like all ETFs, they can be bought or sold at any time.
For example, file
(Stock ticker: PJUL) Protected against the first 15% of losses in
ETF (SPY) for the 12 months ending June 30, 2022. It lost just 0.8%, reflecting the fund’s expense ratio of 0.79%. During that time, the S&P ETF is down 11.87%.
similar ETF,
FT Cboe Vest US Equity Buffer ETF – Jun
(FJUN) of the First Trust, has protected investors against the first 10% of losses in the SPDR S&P 500 ETF for the 12 months ended June 17. It saw a loss of 2.7% (including expenses of 0.85%), compared to an S&P loss of 11.8%.
Dave Allison, president of Prosperity Capital Advisors, which uses temporary ETFs as a substitute for bonds to create portfolio heaviness, says these ETFs provide loss protection for clients when an increase in Fed interest rates caused both stocks and bonds to fall. “They did exactly what they had to do with the wallet,” he says.
There are 149 specific outcome ETFs available. They follow the main indexes, such as
Standard & Poor’s 500And the
The
Nasdaq 100And the
or the
MSCI EAFE.
The five major issuers are Innovator ETFs, First Trust ETFs, Allianz, Pacer and True Shares, with the first two taking the vast majority of market share.
| Source | ETF | ribbon | Buffer negative results period¹ | Score period upside down Cap¹ | Remaining buffer² | Remaining cover² | Total Return³ | expense ratio |
|---|---|---|---|---|---|---|---|---|
| creative | US Stock Strength Stocks – July | PJUL | -15th% | 17.42% | -16.0% | 14.81% | 2.2% | 0.79% |
| first trust | FT Cboe Vest US Equity Buffer- Jul | FJUL | -10 | 21.30 | -11.5 | 19.90 | 1.1 | 0.85 |
| State Street | SDPR S&P 500 Trust | spy | Unavailable | Unavailable | Unavailable | Unavailable | 5.5 | 0.09 |
The results period for the innovator is from 7/1/22 – 6/30/23. The results period for First Trust runs from 7/18/22 to 7/21/23. ² Remaining cap/buffer as of 7/26/22. ³ Return as of 7/26/22; Return of the Spy is one month’s return. N/A = Not applicable
Sources: Innovator ETF; The first confidence is the morning star
Most issuers offer a monthly series of fixed-result ETFs, with the results period typically beginning on the first trading day of each month, although some offer quarterly products. Funds Don’t Expire – After the 12 month period expires, it resets to wherever the underlying index is trading at that time.
While each issuer has its own methodology, they all use Call and put options To determine the position and offset losses in the indicator they track. Because hedging is often expensive, funds sell expensive calls to fund the trade. In contrast, the gains are limited and the downside is limited. (Puts give owners the right, but not the obligation, to sell shares at a specified price at a specified time, while calls give owners the right, but not the obligation, to buy.)
While ETFs can be bought or sold at any time, to receive the announced buffer and cap when the ETF resets, investors are required to hold the fund during the full results period, which is typically one year from the day the results period begins, Bruce Bond says, CEO of Innovator ETFs, which pioneered the strategy.
Once the ETF starts trading, the fund’s daily return will change to reflect the movement of the market and keep the hedge and cover stable. For example, for the period from July 1, 2022 to June 30, 2023, Innovator created the negative buffer in US stock stocks for July at 15% and its upside value at 17.42%, based on the July 1 SPDR S&P 500 price.
After three weeks of trading, with the S&P 500 up, the cap dwindled to 14.7% but the reserve expanded to 16.4%, staying in line with the original results period value.
The fund’s July 21 return was 2.2%, which investors would get if they sold it on that day, while the S&P ETF returned 5.5%. There are two reasons for the yield difference, Bond says: the expense ratio and the slight time lag that options make as they keep pace with the reference asset.
Aniket Ullal, head of ETF data and analysis at CFRA Research, says there are simpler ways for retail investors to try to protect themselves from stock market volatility, such as low-volatility ETFs. While he’s impressed with the specific results strategies, he says understanding how they work takes time.
Specific outcome ETFs are similar to other risk management products Like organized notes, which are securities issued by financial institutions linked to an underlying index or other reference index. Daniel Milan, managing partner at Cornerstone Financial Services, which uses cryptocurrency ETFs and other structured products in its portfolio, says these ETFs give retail investors access to strategies long used by advisors and financial institutions in an easy-to-use way. ETFs offer more flexibility, as they can be bought or sold easily and users benefit from the tax efficiency inherent in ETFs.
“Now they can go into their E*Trade account and type in the ticker symbol and buy it,” he says.
There are some caveats. ETFs are much more expensive than the S&P 500 or Nasdaq ETFs
ETF (QQQ), which has an annual cost of 0.09% and 0.20%, respectively. However, Hagen Pruemm, financial advisor at SIS Financial Group, says that if individual investors were to create these options trades themselves, it would be a lot more work, and a lot more expensive. He uses these ETFs as a way to reduce volatility in stock portfolios.
The biggest caveat is the fund caps. In strong bull markets, such as 2021, it will underperform. This is what we see in the return
Innovative US Equity ETF – January
(BJAN), which had a results period from January 1, 2021 to December 31, 2021. This fund had a downside reserve of 15% and a cap of 15%. Its return was 14%, net of fees, versus the 2021 S&P 500 ETF Trust’s return of 27%.
“The problem really is, people in this environment say, ‘It’s okay, I’m willing to give up on the upside. ‘ And then three years later, they were like, ‘How did you get me into something that made me crowned?’ says Milan.
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