The S&P 500’s inflation-adjusted earnings yield stands at just 2.83% — only marginally higher than the 1.95% 10-Year TIPS yields — suggesting investors are paying a premium for stocks. But, at the same time, the upcoming election, wars in Ukraine and Gaza, and other geopolitical events could dampen demand for risky assets. And that could, ultimately, trigger a sell-off.
Not surprisingly, frothy equity markets and increasing risks have led retirement-focused investors to look for ways to hedge their portfolios. And, over the past few years, buffer ETFs have been the go-to option, drawing more than $50 billion in assets. But, despite their popularity, there are some unique risks to owning these funds.
In this article, we’ll look at a newly launched alternative to buffer ETFs and how you might use these funds to hedge your portfolio against equity market risks.
Buffer ETFs: The Good & The Bad
Buffer ETFs overlay a covered call and put spread onto a long equity position to limit risk. Under the hood, this involves selling an out-of-the-money call option, buying an at-the-money put, and selling another out-of-the-money put. The difference between the put strike prices creates a “buffer” where you don’t lose anything.
While buffer ETFs protect you from a certain percentage loss, the covered call limits the upside potential. A second issue is that, depending on when you purchase the buffer ETF, you may have severely limited upside potential or a much greater downside than the “buffer” percentage suggests, if the stock made a big move between the reset periods.
Some of the most popular buffer ETF issuers include Innovator and FT Vest, both of which offer a series of ETFs divided into outcome periods. For instance, the U.S. Equity Power Buffer ETF – January Series (PJAN) created a buffer on January 1, 2024, that will remain in place until December 31, 2024.
Covered call ETFs offer a similar strategy, but by leaving out the put options, they leave greater upside potential with less downside protection. That said, they come with the caveat of more income, which is taxed at a higher rate than capital gains.
Buffered & Covered Call ETFs
These ETFs are sorted by their YTD total return, which ranges from -0.7% to 8.4%. They have expenses between 0.35% and 1.05% and have AUM between $918M and $8B. They are currently yielding between 0% and 12.8%.
| Name | Ticker | Type | Actively Managed? | AUM | YTD Total Ret (%) | Yield | Expense |
|---|---|---|---|---|---|---|---|
| FT Vest Laddered Buffer ETF | BUFR | ETF | Yes | $3.74B | 8.4% | 0% | 1.05% |
| Global X NASDAQ 100 Covered Call ETF | QYLD | ETF | No | $7.94B | 7.1% | 12.4% | 0.61% |
| Global X S&P 500 Covered Call ETF | XYLD | ETF | No | $2.86B | 7% | 9.4% | 0.60% |
| Global X Russell 2000 Covered Call ETF | RYLD | ETF | No | $1.39B | 2.6% | 12% | 0.63% |
| iShares 20+ Year Treasury Bond BuyWrite Strategy ETF | TLTW | ETF | No | $918M | -0.7% | 12.8% | 0.35% |
TrueShares Takes a Different Approach
TrueShares recently launched a pair of actively managed ETFs offering call and put option-based hedges that you can add alongside your existing portfolio. So, rather than holding an all-in-one buffer ETF, you can purchase one of these funds to hedge your existing long stock positions on an as-needed basis.
The TrueShares Quarterly Bull Hedge ETF (QBUL) invests in short-term income-generating debt securities and uses the income to purchase a modest investment in call options on securities or indexes representative of U.S. large-cap companies. The goal is to generate both income and capital gains from an increase in the market’s value.
Meanwhile, the TrueShares Quarterly Bear Hedge ETF (QBER) takes the opposite approach, investing in put options rather than call options. This position enables investors to benefit from meaningful declines in large-cap stocks while generating income.
“In our opinion, both QBUL and QBER represent versatile portfolio construction solutions for risk averse investors,” says Michael Loukas, CEO of TrueMark Investments. “They’re a natural expansion of our risked-managed equity product suite that can be used singularly or in tandem to navigate both bull and bear market conditions with consistency.”
Both funds establish the options positions over rolling three-month periods, purchasing out-of-the-money or at-the-money call options. The managers aim to capture between 20% and 40% of the market’s gain or decline on a quarter-to-quarter basis. So, investors may face an issue similar to buffer ETFs in terms of timing.
The active funds also charge a modest 0.79% expense ratio that’s on par with many other active ETFs and lower than most mutual funds.
The Bottom Line
Investors may have options when hedging their portfolio against downside risk (or upside risk). While buffer ETFs have become popular, they come with a unique set of tradeoffs that may deter some investors. So, it may be worth checking out alternatives like TrueShares’ bull and bear hedge ETFs, which take a very different approach.
