Should you consider an intra-outcome sale in a rising market?
The decision to make an intra-outcome sale of a Buffer ETF in a rising market isn’t an easy one. Here are several factors to consider:
- What are the current defined outcome parameters for the Buffer ETF you own?
- What is your risk tolerance? Are you a conservative, moderate or aggressive investor?
- Why did you buy your Buffer ETF? What were your investment objectives?
- What are the tax consequences if you make a change intra-outcome period? Is the position held in a tax-deferred or taxable account?
- What is your short-term opinion of the direction of the reference asset in the Buffer ETF you own? Do you fear a correction (drop of 10%) in the reference asset, or more, by the end of the outcome period?
It’s critical you answer these questions before making an intra-outcome sell decision of a Buffer ETF.
Let’s look at a hypothetical example using the price of Innovator’s U.S. Equity Power Buffer – November series (PNOV) on February 2, 2024. Let’s assume you bought PNOV on the last reset date – the start of trading on November 1, 2023 – so your outcome parameters are the same as in the table. As I write, these are the potential outcome parameters shown on Innovator’s website.
Potential Outcome Parameters – February 2, 2024
| Ticker | Asset -30% | Asset -20% | Asset -15% | Asset -10% | Asset -5% | Asset 0% | Asset 5% | Asset 10% | Asset 15% | Asset 20% | Asset 30% |
| PNOV | -10.62% | -8.46% | -8.14% | -2.74% | 2.67% | 5.97% | 5.97% | 5.97% | 5.97% | 5.97% | 5.97% |
| Ticker | Fund Price | Fund Return | Asset Return | Return Difference | Asset Return to Cap | Remaining Cap | Down Before Buffer | Remaining Days |
| PNOV | $34.97 | 8.38% | 18.06% | -9.68% | -1.94% | 5.97% | -8.53% | 272 |
The reference asset (SPY) has skyrocketed in a few short months. SPY is up 18.06% since PNOV’s last reset date. PNOV has lagged SPY by a significant amount (-9.68%), but is still showing a healthy profit of 8.38% in the three months since the last reset date. Should you consider a sale of PNOV to lock in profits? The unrealized gains are not protected during the remainder of the outcome period (272 days), so if the reference asset declines and remains down by a significant amount when the next reset date comes around, you could lose all your profits. So, what factors should be considered to decide if a sale of PNOV makes sense?
Let’s answer each of the questions at the start of this chapter to determine what could be the right course of action:
- What are the current potential outcome parameters for the Buffer ETF you own?
The current potential outcome parameters make a sale of PNOV difficult. Sure, you have a nice unrealized profit of 8.38% in a very short period, but the fact that PNOV has lagged the return of SPY by 9.68%, makes a sale problematic. Why? Well, there are potential gains you could forgo by selling now. If SPY goes nowhere (“Asset Flat”), and even if SPY declines by no more than 5%, you’d still make more money in the position by the end of the outcome period. Look at the column titled “Asset -5%.” You can see that if SPY declines by 5%, you will still make another 2.67%. The prices of the option contracts within the Buffer ETF have caused the NAV of the ETF to lag SPY by a significant amount early in the outcome period (not atypical in a fast-rising market). However, PNOV should eventually “catch up” somewhat as the ETF nears the end of the outcome period (and perhaps sooner) due to time-value erosion as the options near expiration.
You should also consider that even if SPY is flat at the end of the outcome period, PNOV will still make another 5.97%. That’s not a bad return for a market that goes nowhere from its current level to October 31, 2024 (next reset date). Note, the upside for the ETF is capped at 5.97% from the current level of SPY to the end of the outcome period, so if SPY gains even more, you will not participate in those gains – you’ll be capped out at 5.97% from the current level.
My opinion is the potential outcome parameters make it tough to sell PNOV and lock in the 8.38% profit. SPY could be flat from its current level to the end of the outcome period, and you would still make nearly 6% more if you hold your position. And, if SPY declines 5% from the current level, you’ll still make another 2.67%.
- What is your risk tolerance? Are you a conservative, moderate or aggressive investor?
If you have a very low tolerance for risk, you may be inclined to take your 8.38% profit. The column titled “Downside Before Buffer” indicates that if PNOV gets hit hard at the end of the outcome period, you could lose the unrealized gain. If PNOV declines by 8.53% your “buffer” would then kick in for the next 15% decline. (PNOV is buffered against the first 15% loss from the price level on the reset date). However, a conservative investor might not want to risk losing the 8.38% profit that PNOV is currently showing. The more risk averse you are, the more inclined you might be to take your profits. Again, a conservative investor might not want to risk losing the unrealized gains that could evaporate if PNOV takes a tumble at the end of the outcome period. Note, there are still 272 days remaining in the outcome period, which could seem like an eternity in a volatile market. - Why did you buy the Buffer ETF? What were your investment objectives?
The reason for your purchase of PNOV could greatly influence whether or not you make a sale of shares intra-outcome. Did you buy PNOV mainly for the 15% downside protection or were you more focused on the nearly 15% upside potential (upside cap set on the last reset date)? At the outset, would you have been happy to capture a gain of 8.53% in just three months? 8.53% in three months is an annualized return of over 30% – not bad at all. So, if you are content with a 3-month return of 8.53%, and you are more focused on not losing the unrealized gains than trying to capture the additional 5.97% maximum return, then you may decide to sell now. - What are the tax consequences if you make an intra-outcome sale? Is the position held in a tax-deferred or a taxable account?
Your answer to this question could also greatly influence your decision. If you hold PNOV in a taxable account and the position shows a quick short-term gain, you’ll likely want to hold it to avoid paying taxes (ordinary income tax on a short-term capital gain). If you hold to the next reset date and get to long-term tax status (more than a year), this could result in substantial tax savings, assuming you eventually sell at some point after reaching long-term capital gain status. Of course, by holding the position you know the unrealized gains could disappear before the next reset date, but you also know that you have a chance to make another 5.97% and avoid a short-term capital gain tax hit. I’d lean towards holding the position to at least get to long-term tax status. Obviously in a tax-deferred account you don’t have to concern yourself with taxes at all, so this topic would be moot. - What is your opinion of the short-term direction of the reference asset (SPY) in the Buffer ETF you own? Do you fear a correction (10% drawdown) or deeper decline, at the end of the outcome period?
Your opinion as to the direction of the reference asset in the coming months could greatly influence your decision to hold or sell PNOV. If you fear a serious decline in SPY, for whatever reasons, you may be inclined to sell and capture your profits now. Yes, you could owe taxes on your gain, but if you’re worried about a decline of 8.53% or more in PNOV (“Downside Before Buffer”), and it happens, then your profits will erode and perhaps turn into unrealized losses, and you’ll likely kick yourself for not selling earlier. If, on the other hand, you expect SPY to be relatively stable (range-bound sideways action) or even move higher in the coming months, then you’ll likely want to hold your position and capture the additional 5.97% gain over the remainder of the outcome period.
There are a lot of factors to consider in this hypothetical example of PNOV. You’ve had the good fortune to have made a very nice profit in a short period of time, but the fact that PNOV has lagged the reference asset (SPY) by a significant amount makes a decision to sell quite difficult. Your answers to the questions in this chapter should help you make the right decision for you.