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Options Strategies in ETFs, Part 1: A Grand Overview
This article is the first part of ETF Central's 4-part series on how ETFs use various options strategies.
The ETF industry continues to grow at a steady pace. According to the ETF Central Screener, as of October 24, 2023, there are a total of 3,320 U.S.-listed ETFs available for investment.
This can be attributed to a combination of factors: the advantages of economies of scale, the rise of white label services, and an unwavering demand from investors. Both legacy fund providers and budding entrepreneurs are finding it increasingly feasible to navigate and prosper in this space.
A particularly intriguing and growing segment within the ETF domain is ETFs that employ options strategies. Out of the 3,320 ETFs cataloged by the ETF Central Screener, 314, or roughly 9.5%, utilize options in their investment approach. But what exactly are options strategies?
At their core, options strategies involve contracts that give investors the right, but not the obligation, to buy or sell an asset at a specific price before a specific date. They are utilized for a range of objectives, from income generation and risk mitigation to capitalizing on market movements.
The beauty of the ETF structure is in its democratizing effect. By integrating options within an ETF, it allows retail investors and advisors to gain exposure to these strategies without the necessity of trading options directly. This has been a game-changer in bridging the gap between sophisticated financial tools and the general investing public.
As the landscape of options-based ETFs becomes richer and more varied, it's crucial to have a comprehensive understanding of its nuances. This article serves as the inaugural entry in a four-part series dedicated to dissecting and examining the current options-based ETF landscape.
Historical Perspective
The first ETF to use options as a core part of its strategy was the PowerShares S&P 500 BuyWrite Portfolio (ticker: PBP). Launched in December 2007, this ETF was designed to track the CBOE S&P 500 BuyWrite Index [1].
The strategy, known as a "buy-write" or "covered call" strategy, involves holding a portfolio of the stocks in the S&P 500 Index and simultaneously writing (or selling) call options on the S&P 500 Index. The goal of the strategy was to generate additional income from the option premiums, which can help to reduce volatility and potentially enhance returns in certain market conditions.
PBP still exists today, albeit re-branded as the Invesco S&P 500 BuyWrite ETF (
The introduction of the Global X S&P 500 Covered Call ETF (
Later on, the volatile market conditions resulting from the 2022 bond bear market led investors to seek refuge in options-based ETFs. One such product, the JPMorgan Equity Premium Income ETF (
More recently, Defiance ETFs made a significant contribution to the industry with the launch of the Defiance S&P 500 Enhanced Option Income ETF (
Why are investors buying these ETFs?
Moreover, many of these ETFs provide monthly distributions, compared to dividend stocks that usually pay out quarterly. This regular income stream is appealing to investors who prioritize steady cash inflows and have a psychological aversion to selling shares.
The mechanics behind options can augment returns. For instance, by selling call options, an ETF can generate additional income which is then passed on to the shareholders. This technique can be especially beneficial in flat or moderately bullish markets.
Additionally, options provide tools to hedge against market downturns and reduce overall portfolio volatility. In uncertain markets, the promise of downside protection becomes an attractive feature for cautious investors.
This was evident with the performance of JEPI during the 2022 bear market. When compared to both the S&P 500 and a conventional 60/40 portfolio, JEPI showcased its resilience and capability to outperform.
Finally, certain ETFs exploit options to simulate a leveraged stock position, aiming for magnified returns. By strategically buying options, these ETFs can potentially amplify their gains in bullish market scenarios, making them attractive to investors with a higher risk tolerance seeking increased return potential.
The key takeaway
Options-based ETFs have carved a distinct and influential niche. From their inception to the present day, they have continuously evolved, offering investors a blend of enhanced yield potential and sophisticated risk management tools.
As we've seen, the benefits of options-based ETFs extend beyond mere yield enhancement. They encapsulate a broad spectrum of strategies, each designed to address specific investment objectives, be it steady income, hedging against market volatility, or amplifying potential returns.
While this article provides a foundational understanding, there's much more to uncover. In our upcoming series, we'll dive deeper into the world of options strategies within ETFs. Part 2 promises to explore a strategy many investors might find familiar – the covered call ETF.
Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.
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