It’s a class of exchange-traded funds designed to keep your portfolio from hitting dramatic bottoms — but it can take a certain level of sophistication.
The Idea: Integrate short-term leveraged plays, including covered call and risk-reversal strategies, to help investors adjust their own defensive strategies in a similar way to hedging.
However, it may come at an unintended price. According to BNY Mellon’s Ben Slavin, issuers and advisors may struggle to keep up with constant product growth and changes.
“The toolkit has grown immensely over the past few years and will continue to grow,” the company’s global head of ETFs told CNBC’s ETF Edge last week. “However, the negative is really trying to analyze all these different products. Really understand what you own and explain that to investors or even advisors who are struggling to keep up with the nuances between these products.”
Liquidity providers and asset servicers may also face difficulties with product expansion, he added.
Nevertheless, investors with a low risk tolerance can benefit from it.
Andrew McOrmond, Managing Director at WallachBeth Capital, spoke to Slavin about “ETF Edge” to explain how leveraged products allow investors to hold defensive, risk-off positions.
Play the leverage game
Covered calls offer protection to customers who want to minimize losses, McOrmond said. These short-term leveraged games better define outcomes, but in turn, investors can miss out on profits.
“If you sell options and the market moves against you, you are protected – but you will only reduce your upside potential [potential]’ he explained, noting that covered calls are ‘the only option’ for risk-averse clients as hedging is complicated for individuals.
McOrmond sees a potentially good hedging opportunity in the recent market rallies. In July, the Nasdaq was up 12% and the S&P 500 was up more than 8%.
Buffer the punch
The First Trust Cboe Vest Fund of Buffer ETFs, ticker BUFR, is designed to provide capital appreciation and limit downside risk for investors, according to the financial advisory firm.
“The name is perfect,” McOrmond said of the Cboe Vest Fund. “You’re buffered on both sides.”
The defensive strategy uses ladders to preserve capital and option collars to “buffer” the investment to mitigate losses investors may face.
Slavin also proposes the fund of buffer ETFs, citing interest and activity in this area.
The First Trust Cboe Vest Fund of Buffer ETFs is up more than 5% this month.
Disclosure: Neither Andrew McOrmond nor Ben Slavin own any First Trust Cboe Vest Fund of Buffer ETFs products.