What are Buffer ETFs?
Buffer ETFs are revolutionary products that provide a range of potential outcomes to investors before they invest. These differ from undefined ETFs by setting parameters to the upside and downside. The ETFs offer exposure to the price return of a reference asset (either a broad market ETF or index), to a cap over a 3-month, 6-month, or 1-year outcome period, at which point each ETF will reset. Historically, these types of defined outcome strategies have only been available through structured notes and certain insurance products.
How do Buffer ETFs work?
Each Buffer ETF holds a customized basket of FLEX options with varying strike prices (the price at which the option purchaser may buy or sell the security at the expiration date), and the same expiration of approximately one year. This gives each ETF a defined buffer level and upside growth potential (to a cap), over an outcome period. Each ETF intends to roll options components annually, on the last business day of the month associated with each ETF.
How are Buffer ETFs created?
Buffer ETFs are typically created with FLEX options. FLEX options offer customized terms of an option, including strike prices, underlying reference assets and expiration dates. They also trade on an exchange, listed on the Chicago Board Options Exchange, and are backed by the Options Clearing Corporation (OCC).
The OCC is guarantor and central counterparty with respect to options. As a result, the ability of a Buffer ETF to meet its objective depends on the OCC being able to meet its obligations.
Designated as a Systemically Important Financial Market Utility (SIFMU), the OCC has heightened risk management and liquidity standards, significantly reducing counterparty risk. Buffer ETFs are not backed by the credit of an issuing institution and therefore are not subject to credit risk.
What are the benefits of the ETF wrapper?
Intraday liquidity, pricing transparency, and tax efficiency are just a few of the benefits derived from the ETF structure.
What are the expense ratios?
Most Buffer ETFs have annual expense ratios of approximately 0.80%. However, there are some Buffer ETF offerings with annual expense ratios of 0.50%.
What if I buy shares of a Buffer ETF after the reset date?
Investors purchasing shares of a Buffer ETF after its launch date may receive a different payoff profile than those who entered the ETF on day one. However, investors purchasing shares after the first day will still be able to know their potential outcomes, no matter when they invest during the one-year period, based on the current ETF price and the length of time remaining before expiration. Visit the issuing company’s website to see the current parameters for all their Buffer ETF offerings before investing.
If I buy shares of a Buffer ETF at its initial price ($25) on the first day of trading, at the end of the outcome period can I expect to participate in the upside of the reference asset to a cap, with a downside buffer level (e.g., 9%, 10%, 12%, 15% or 20%), before fees and expenses?
Yes. These ETFs are designed to provide point-to-point exposure to the price return of the reference asset. They are not expected to move precisely in line with each respective reference asset during the outcome period (due to the optionality of the underlying portfolio). It is also important to note that there is no assurance that Buffer ETFs will meet their investment objectives.
Does a Buffer ETF mature?
No. Upon the conclusion of the outcome period, the ETF will automatically reset into a new portfolio with the same exposure, buffer level, and term, and a new upside cap will be determined.
Does any entity guarantee I will not lose my investment?
No. Unlike certain insurance products and structured products, ETFs are not backed by the faith and credit of an issuing institution like an insurance company or a bank. This also means that Buffer ETFs are not exposed to credit risk. The options held by the ETFs are guaranteed for settlement by the Options Clearing Corporation (OCC). In the unlikely event the OCC becomes insolvent or is otherwise unable to meet its settlement obligations, the ETFs could suffer significant losses. However, regulators have heightened their oversight of the OCC due to its designation as a Systemically Important Financial Market Utility (SIFMU).
Are there any comparable products that exist in the market?
Buffer ETFs are designed to offer investors more efficient, cost-effective, and more accessible alternatives to structured notes and certain insurance products. While those products can play an important role in certain investors’ portfolios, characteristics like high fees, illiquidity, lack of transparency, and counterparty risk have set the stage for an alternative, such as Buffer ETFs. Many of the benefits of defined outcome products can be harnessed efficiently and cost-effectively in an ETF wrapper.
Buffer ETFs appeal to what type of investor?
The ability to know potential outcome parameters before investing has countless applications. Buffer ETFs appeal to a range of investors seeking stock market growth, to a cap, with a downside buffer. These may include conservative or moderate-risk investors, high-net-worth investors, retirees and pre-retirees.
Can an investor buy and hold a Buffer ETF, or do they need to repurchase the ETF each year?
Buffer ETFs automatically “reset” at the conclusion of their respective outcome periods and may be held indefinitely. At the end of an outcome period, each ETF will roll into a new set of options contracts with the same exposure, buffer level, and term length, and a new upside cap will be determined.
Are Buffer ETFs a good fit for my portfolio?
Buffer ETFs can be used as a complement or replacement for both equity and fixed income allocations in existing portfolios. The inherent flexibility of the ETFs, and the price discovery and intraday liquidity now afforded to structured outcomes, make Buffer ETFs an attractive addition to a portfolio.
Are there benefits to Buffer ETFs over structured products and indexed annuities?
Buffer ETFs attempt to solve several issues often associated with structured products that seek to provide investors with known return profiles: liquidity risk and counterparty credit risk. Buffer ETFs are fully transparent and more flexible than the typical structured products you might find in the marketplace.
When can I trade?
Buffer ETFs invest and capture market exposure in the deepest, most liquid markets in the world. Buffer ETFs allow investors to trade in large sizes at competitive prices. It is critical to remember that liquidity of an ETF is driven by the underlying exposure held by the ETF, not the ETF itself.
Investors can buy and sell Buffer ETFs just like any other ETF. These ETFs are actively quoted/traded during market hours. Furthermore (unlike traditional structured products), investors can buy and sell at any point during an outcome period with ease. Investors can also remain confident that their execution will be consistent due to the deep liquidity profile underlying the Buffer ETFs. The tradability of Buffer ETFs is yet another benefit of the ETF structure, and it allows investors to transact with minimal friction.
If an investor decides to transact intra-outcome period, the current ETF potential outcome parameters can be viewed on the issuer’s website.
When should I trade?
While investors may initiate a position at any point during an outcome period, activity tends to be highest around the rebalance date for the Buffer ETFs. Why is this the case? Investors who purchase and hold these ETFs from the start to the end of an outcome period will receive the stated cap and buffer levels. Investors who purchase after the first day of an outcome period will also experience a defined outcome (but with a different set of caps and buffers) if they hold for the remainder of the outcome period. For investors seeking the stated caps/buffers, it’s recommended they initiate a position in the final hour of trading on the day before the new outcome period begins.
What if I see low volume on a Buffer ETF prior to entering an order?
Low volume should be of no concern. An ETF’s liquidity is derived from the liquidity of its underlying components. Buffer ETFs track the largest and most well-known underlying indices, so there is considerable liquidity underlying each of the ETFs. If desired, an investor can always enter a limit order for a purchase or sale.
Is there a minimum or maximum order size?
No.
Buffer ETF Definitions:
“Reference asset exposure” is the reference asset the ETFs are providing structured exposures to.
“Cap” refers to the maximum potential return, before fees and expenses, if held to the end of the current outcome period. The ETF does not participate in growth beyond the cap.
“Buffer” refers to the amount of downside protection, before fees and expenses, the fund seeks to provide, over the full outcome period.
“Outcome Period” is the intended length of time over which the defined outcomes are sought. The remaining terms are applicable to those considering an investment in an ETF during the outcome period.
“Remaining Upside Cap” is the current maximum return available at the ETF’s current price, before fees and expenses, if held to the end of the outcome period. Remaining upside cap is a function of the ETF’s return, not the return of the index. The reference asset may need to rise higher or lower than the remaining upside cap before the cap is realized.
“Remaining Downside Buffer” is the current amount of downside buffer remaining at the ETF’s current price, before fees and expenses, if held to the end of the outcome period.
“Downside Before Buffer” is the amount of ETF loss incurred before the buffer begins. This is applicable to people considering an investment during the interim period.
“Remaining Outcome Period” is the number of days remaining until the last day of the outcome period.
“Fees and Expenses” include the ETFs’ management fees, any shareholder transaction fees and any extraordinary expenses.
Option Definitions:
Call Option: a call option gives the buyer the right to buy an asset at a specified price.
Put Option: a put option gives the buyer a right to sell an asset at a specified price.
Strike Price: the agreed-upon price at which an underlying asset can be bought or sold.
At-the-Money: an option is at-the-money if the strike price and price of the underlying asset are equal.
In-the-Money: an option that possesses intrinsic value. An option that’s in-the-money is an option that presents a profit opportunity due to the relationship between the strike price and the prevailing market price of the underlying asset.
In-the-Money Call Option: the option holder can buy the security below its current market price.
In-the-Money Put Option: the option holder can sell the security above its current market price.
Out-of-the-Money: a call option is out-of-the-money if the underlying price is trading below the strike price of the call. A put option is out-of-the-money if the underlying price is above the put’s strike price.
