We have previously talked about how exchange-traded funds (ETFs) represent a skilled device to achieve a variety of assets or quick access to investment exposure. We have also discussed how options have become increasingly popular in recent years.
Today, we connect both subjects and look at ETF which includes options. We see that this is a growing section of the ETF landscape.
ETFs with options give different returns in stock portfolio
Options do slightly different things compared to equity. The options are finished – sometimes in money, sometimes – do not make their returns “linear”. In addition, there can be options:
- Personally held (single leg).
- Combined with other options (multi-foot).
- Combined with the built -in equity exposure (overlay).
It can be used to create portfolio with various payments, such as additional income or negative security.
ETFs are growing with options
As the data below suggests, the assets in the option overlay ETF have increased significantly since 2020, when the markets experienced a sharp sale around the Kovid -19 epidemic.
Prior to 2020, the total assets under Management (AUM) in this category were $ 5 billion. Today, the same type of strategies represents more than $ 160 billion, with either increased income or hedging strategies (later more on differences) with bulk of property invested.
Chart 1: Property in Option Overlay ETF
In fact, when we look at the annual ETF launch, we see that option overlay funds usually represent between 20% to 30% of the new equity ETF launch since 2019 (Chart 2).
Chart 2: Option Overlay ETF launch
Are the options overlay the most popular?
Not all options overlay strategies are the same. Options can be combined simultaneously in a portfolio to target a pre-defined result. In Chart 3, we NASDAQ’s In-House Fund According to Taxonomy Group Fund:
- Increased income strategy (green) Try to increase income mainly. This is usually performed by writing, or selling, options for earning premium income in addition to long equity exposure (eg, covered like Qayal or Put-Right like WTPI).
- Hedging strategies (orange) Protecting the negative side by providing some reverse participation through long put options primarily, and the short call options (eg, PDEC and FNov such as traditional buffer funds, or 100% negative security funds such as FNOV) offer.
- Extended performance (blue) Try to improve a benchmark through increased income (eg, OVL, or SPYC).
By March 2025, we extended over 430 equity ETFs with options, representing more than $ 160 billion in the total AUM. However, as we can see below, income and hedging strategies represent almost all of the total assets in the space.
Chart 3: Option Elley ETF by strategic focus
How do they work?
Each overlay strategy is usually some combinations of long and shorter conditions in calls and put options, which all give slightly different results. The diagram below explains how a combination of stock exposure (diagonal line) and option exposure (“hockey stick”) adds an indication portfolio returns profile that “not linear” (the blue line is not straight).
Chart 4: Different types of options overlay’s imaginary payment
The diagram above explains how some popular overlay strategies work. Note that a trade is usually closed to produce these returns. The blue line is sometimes above the diagonal stock return (better), and sometimes it (worse) under it.
Each benefits are also different:
- Calling call – Produce income with limited reverse.
- Protective put – Perfectly protect the negative side but participate inverted.
- Traditional buffer fund – Produce buffer negative (up to a certain point) and some reverse equity participation.
- 100% negative protection (or collar) – Similar to traditional buffer funds, except the negative side is fully preserved.
Cover call and a deep dive in protective put
The first option in the US market, buy S&P 500 in the US market/Write ETF (PBP), which implements a cover call strategy on S&P500.
A cover call usually consists of two positions:
- Long equity exposure In the words, the value of the situation goes up or down 1 -to -1 with an underlying stock price.
- Short call option – Assuming that the situation is held for termination, if the price of stock is less than the strike price, the situation keeps premium. Otherwise, the position loses the value.
The premium earned by selling the call helps the joint portfolio defeat a simple stock fund, even though the joint exposure (blue line) still falls as a fall in stock prices. However, once the small call is “in money,” the option exercise pays offset (covering) on the benefit on the payment stock. The short call is overturned by call strike.
On the other hand, a protective put stock portfolio acts like insurance against fall (below the strike price). The joint portfolio still provides exposure to upside down, but the cost of the option (premium) reduces the return than a simple stock position (the blue line falls under the long stock line).
Chart 5: Long Equity + Single Options
Overall, the total assets under the management (AUM) have about 70 types of American funds applying strategies such as cover calls with approximately $ 90 billion.
A deep dive in buffer strategies
Buffer strategies are slightly more complicated with many layers of options. The purpose of buffer strategies is to provide negative security and some reverse possession.
Generally, there are four major components of a traditional buffer strategy, and the chart below shows each stage sequentially (note that the dark blue line represents the net payment profile for each step):
1. Install equity exposure – Either by going to the index for a long time or buying a deep-in-money call option.
2. Set “Cap” – By selling an out-of-the-money call option. It establishes “cap,” or how much the strategy can reverse the strategy.
Set by buffer range:
3. Long put option – Establish the beginning of a buffer.
4. Short put option – Installs the end of the buffer and also partially funds negative buffer.
Chart 6: How to make buffer
Overall, Chart 6 in Chart 6 highlights the required payment during a combination of all components. However, we should note that the payment paid may be distracted by the expected payment shown above based on other factors, such as when an investor buys or sells the strategy relative to the start and end of the defined result period.
The major trade closed upside is potential vs. negative security. The buffer strategy can only earn returns up to the cap, so if the reference property is more than the cap, the buffer strategy will be weak.
Despite the potential underperformance in the “up” markets, investors can still be designed for buffer strategies, which in combination to earn some premiums back in combination due to their ability to limit only at a lower cost than “a put purchase”.
Note that, generally, buffer strategies have historically improved the underlying benchmark during the market tension period. For example, a rolling drawdown of a collection of buffer strategies from 2020 below to current is highlighted, relative to Nasdaq -100® (NDXX®) and S&P 500. This indicates that the gray area falls less than a simple stock portfolio (dots).
Chart 7: Rolling Drawdown of Buffer Fund
Who is managing these ETFs?
Interestingly, most of the assets are managed by some ETF issuers (Chart 8):
- JP Morgan is the largest issuer, with about 65 billion dollars in property and two largest ETFs (JEPQ and JEPI).
- They are after the First Trust and Innovators ETF, which focus too much on negatively protected (orange) strategies.
- Although Global X, Emplifift and NEO have low ETFs, their suites include some of the most popular ETFs with options (Qualized, XYLD, Divo and SPYI).
Chart 8: Top ETF issuer of option overlay
Why does it matter
Option strategies can be sewn to complete a variety of defined results. ETFs with options make it easy for investors to reach some of these complex strategies.
However, because these types of strategies are complex, they cannot be for everyone. As always, it is important to understand investors What They are purchasing to avoid any unwanted results.
Overall, option overlay strategies show another example of how American markets have developed.
