The ETF landscape grows ever more saturated, with more than 1,000 new product launches in the first seven months of the year. That’s a record amount of new issuance. Providers are conjuring up endless ways to slice and dice the market, using both passive and active methodologies.
Amid the sea of new offerings, nearly 50% of all ETF product launches have employed financial derivatives, such as futures and options contracts, to achieve their investment goals. These ETFs may aim to manage risk, hedge an asset, or make amplified bets on or against a stock or index. They essentially provide any strategy and return profile that cannot be achieved using only cash products.
VettaFi’s own indexing team has been knee-deep in conversations with issuers about derivatives and structured products. They have had more discussions about them in the last two weeks than they’ve had in the last two years.
Covered calls, structured buffers, and single-stock leverage remain among the most popular of these strategies. These essentially aim to structure outcomes for different investment objectives only achievable through the use of derivatives. Most rely on active management methodologies meant to generate additional alpha. They also tend to charge higher management fees.
Weighing Your Options: Enhancing Income
Covered call (also called “BuyWrite”) strategies, allow investors to sell call options on securities they hold and collect premiums. Essentially, they’re trading upside price appreciation for immediate income. For investors who want to stay in the market, these products can serve as attractive alternatives to equities by providing incremental returns while cushioning against downside volatility. They tend to perform particularly well in range-bound markets.
Fidelity recently rolled out its Yield Enhanced Equity ETF (FYEE ) and Dynamic Buffered Equity ETF (FBUF ). Both use covered calls. FYEE invests in large-cap companies and sells out-of-the money covered calls to generate income. FBUF uses a “defensive option collar” to mitigate risk.
Fidelity’s Hedged Equity ETF (FHEQ ) is a relatively newer entrant. But it has already amassed north of $400 million in net inflows. It’s up 4% over the past month on a total return basis. The fund uses long puts to buy protection against meaningful market drawdowns, focusing solely on defensive positioning. FHEQ carries a net expense ratio of 0.48%.
The NEOS Nasdaq-100 High Income ETF (QQQI ) also came to market earlier this year. So did its Russell 2000 High Income ETF (IWMI ). Rather than relying on mechanical methodologies, NEOS employs customized, data-driven call writing strategies with a special focus on tax efficiency in its trade selection.
NEOS also has enhanced bond products, like the Enhanced Income Aggregate Bond ETF (BNDI ) and the Enhanced Income 1-3 Month T-Bill ETF (CSHI ), that use put-spread options overlay strategies.
Buffer Products: Cushioning the Blow
The pain of a loss stings much more than the pleasure of a gain. In behavioral economics, this is known as loss aversion. For those worried about a larger market correction, certain options-based ETFs can help reduce the risks of a diversified portfolio.
Calamos, which started out as a convertible shop, recently launched its Calamos S&P 500 Structured Alt Protection ETF (CPSM ). The fund focuses on downside protection with capped upside potential. It’s designed to match gains in the S&P 500 up to a defined cap while protecting against 100% of losses over a one-year period. CPSM may prove especially attractive for retirees looking to de-risk. The ETF charges 0.69%.
Goldman Sachs also recently filed for a suite of large-cap buffer ETFs. The firm is gearing up to bolster its defined outcome ETF lineup.
Leveraged & Inverse ETFs: Proceed with Caution
Defiance’s brand-new Daily Target 1.75x Long MSTR ETF (MSTX ) has been making waves among the crypto community. This highly speculative product is just the latest example of a heavily levered ETF that offers single-stock exposure to an extremely volatile firm that many consider one of the Street’s biggest bitcoin proxies. MSTX charges a hefty 1.29% expense ratio.
Note: These products are not viable for long-term buy-and-hold investors. Much as the magic of compounding should compel investors to save, the risk of compounded losses ought to repel them from making outsized bets.
As the ETF market continues to expand with innovative products, investors are presented with a plethora of options that cater to diverse investment strategies and risk appetites. While derivatives-based ETFs offer sophisticated tools for managing risk and enhancing returns, they also demand a deep understanding and careful consideration of potential risks. Ultimately, the success of these products will depend on their ability to deliver on their promises while maintaining transparency and accessibility for all types of investors.
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