Parametric's Innovation Continues Under New Leadership from Morgan Stanley with Launch of PHEQ and PAPI

PHEQ breakdown and analysis

PHEQ is the latest ETF to implement an options overlay designed to limit volatility and drawdowns in its portfolio. Its base portfolio closely resembles the S&P 500, holding 500 of the largest U.S. companies weighted by their market capitalization.

To augment this, PHEQ deploys an options overlay that will cap its upside while providing some downside protection.

Specifically, PHEQ looks to buy puts at around 10% below its current index price, while selling a put at around 30% lower. This is the put-spread component of its strategy. Simultaneously, the ETF will also sell a call option, and use the premium received to further offset the cost of the put spread.

This options overlay creates a payoff structure where any initial losses in the ETF's underlying index will be mitigated, or "buffered" to an initial extent thanks to the purchased put. However, if losses steepen, the ETF will begin participating in losses again due to the sold put. In addition, the sold call will naturally cap upside participation.

To maintain coverage, PHEQ will implement a "laddered" strategy, holding different options legs for multiple one-year periods, each staggered three months apart. This makes the ETF similar to buffer ETFs already on the market but with an indefinite outcome period.

Right now, investors can expect quarterly distributions along with a fairly attractive 0.29% expense ratio, which is very competitive as far as actively managed options strategy ETFs go. So far, PHEQ has attracted just over $21 million in AUM since its inception on October 16th, 2023.

PAPI analysis and breakdown

Compared to PHEQ, PAPI is less complicated and easier to understand for retail investors already familiar with covered call ETFs like the popular JPMorgan Equity Premium Income ETF (JEPI).

This ETF blends both active stock selection and options management. It begins by selecting a portfolio of dividend stocks from the Russell 3000 Index, and then augmenting it with S&P 500 index or ETF options for additional yield potential.

The active stock selection employs a rules-based strategy whereby Parametric looks for a combination of high income and lower volatility, which they term "durable dividend payers." Within the ETF, sectors will be equally weighted.

As for the covered call overlay, Parametric intends to write calls with two weeks until expiry, setting it apart from the one-month-until-expiry calls used by most competitors. Importantly, sold calls will also be out-of-the-money (OTM), which preserves more potential for upside appreciation.

The use of more frequent, short-dated (two weeks till expiry) call options has the potential to maximize the returns from time decay, known as theta. In addition, Parametric's active management of the options overlay will involve laddering, a technique used to stagger multiple legs over different expiration dates.

PAPI's distribution yield is still to be determined as of November 7th but is projected to be considerable. Monthly distributions will be a feature of this ETF given its income-centric focus. As with PHEQ, investors can expect a fairly low and competitive 0.29% expense ratio.

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.