Should you consider an intra-outcome sale in a declining market?
Let’s look at some factors that should be considered before making an intra-outcome sale of a Buffer ETF in a declining market, also known as a “step-down.” In this chapter, let’s assume you purchased all three of the Innovator January series Buffer ETFs on the most recent reset date (first business day of 2022). The reference asset (SPY) has suffered a deep decline since the reset date and all three positions show unrealized losses. Should you consider selling your holdings and perhaps rotating into a different Buffer series? Here are some factors to consider:
- What are the current potential outcome parameters for your Buffer ETFs?
- How far has the reference asset (SPY) declined and how have the Buffer ETFs performed?
- How much time remains in the outcome period of the Buffer ETFs?
- What is your risk tolerance? Are you a conservative, moderate or aggressive investor?
- Are the positions held in a taxable account? If so, is it advantageous to sell and harvest tax losses?
- What is your short-term opinion of the direction of the reference asset (SPY)? Do you think it will decline further and finish even lower at the end of the outcome period? Or, will SPY recover somewhat by the end of the outcome period (only 92 days left)?
- What are the starting upside caps for the three Buffer ETFs (BOCT, POCT and UOCT) that are now resetting on October 1, 2022? Are the upside caps attractive enough to consider “stepping-down” and rotating into the October series?
Let’s look at a hypothetical example using Innovator’s three Buffer ETFs – January series (BJAN, PJAN and UJAN), on September 30, 2022. At the time, the stock market was in a bear market and the S&P 500 had lost nearly 25% over the past 9 months. Let’s assume you bought BJAN, PJAN and UJAN on the last reset date, at the start of trading on the first business day of 2022.
Potential Outcome Parameters – September 30, 2022
| Date | Ticker | Fund Price | Fund Return | SPY Level | SPY Return | Remaining Cap | Remaining Buffer | Downside Before Buffer | Remaining Outcome Period |
| 9/30/2022 | BJAN | $30.99 | -16.89% | 357.18 | -24.80% | 35.81% | -1.28% | 0.00% | 92 Days |
| 9/30/2022 | PJAN | $29.44 | -11.45% | 357.18 | -24.80% | 22.36% | -0.69% | 0.00% | 92 Days |
| 9/30/2022 | UJAN | $29.17 | -7.59% | 357.18 | -24.80% | 14.98% | 15.77% | 0.00% | 92 Days |
In the table you can see the potential outcome parameters for the three Buffer ETFs on September 30, 2022. As a refresher, BJAN provides protection against the first 9% loss from the prior reset date, PJAN offers 15% protection, and UJAN provides 30% protection, but not on the first 5% loss (-5% to -35%).
So far in 2022, the reference asset (SPY) has been crushed and is showing a loss of 24.80%. All the Buffer ETFs have held up much better than SPY, as they should during a correction or bear market. UJAN has provided the most protection, showing an unrealized loss of only 7.59%. Nevertheless, all three positions have lost money since the last reset date (“Fund Return”). So, should you “step down” and realize the losses (tax-loss harvest), and perhaps “rotate” into a new Buffer series with additional downside protection, and a new upside cap? What factors should you consider before making a sale of any or all of the Buffer ETFs?
The additional information below should also be considered prior to making a sale:
Upside caps for the January Series Buffer ETFs on the first trading day of 2022:
BJAN: 13.5%
PJAN: 8.99%
UJAN: 6.89%
Current upside caps for the 2022 October Series Buffer ETFs:
BOCT: 28.45%
POCT: 20.72%
UOCT: 17.08%
Let’s answer the following questions to determine what might be the right course of action:
- What are the current potential outcome parameters for your Buffer ETFs?
The current outcome parameters make a sale of all the holdings in the January series potentially attractive. The Buffer ETFs have all outperformed the reference asset. For example, UJAN is only down 7.59% while SPY is off 24.8%. This could present an attractive risk-reward scenario from the current lower level of SPY. You could swap out of UJAN, take the tax loss, and purchase BOCT, which has an upside cap of 28.45%, which is considerably higher than the 6.89% upside cap on UJAN at the start of the outcome period (January 1, 2022). BOCT would also provide an additional 9% downside buffer from the current level, while providing a starting upside cap that is much higher than the remaining upside cap of UJAN (14.98%).
A sale of PJAN, which shows a loss of 11.45% (half the loss of the reference asset), is also worth considering. Since PJAN has outperformed SPY by a considerable amount, you are in a good position to swap out of PJAN, harvest a tax loss, create a fresh buffer on the downside, and also increase the upside cap. You could swap into the 9% or 15% series. The 9% buffer, October series, offers an upside cap of 28.45%, and the 15% buffer offers an attractive 20.72% upside cap with additional downside protection of 15%. Sure, you would be locking in a loss, but by not selling, you risk deeper losses because the ETFs are no longer “buffered” against losses (the reference asset has breached the buffer zone). At this point, you don’t know if SPY is going to fall further or recover quickly, but by rotating into a new Buffer series you could add more downside protection and still have the potential to recover nicely, with the high upside caps offered by the October series.
A sale of BJAN is perhaps more difficult. It provided minimal protection (9% before fees) against the losses of the reference asset, losing 16.89% to SPY’s 24.8% decline, and it still shows an upside cap of 35.81%. So, if SPY recovers fast, you could recoup some losses. However, with only 92 days remaining in the outcome period, it is unlikely that SPY will recoup a significant portion of the losses, and there is also the risk that SPY continues to decline and there is no remaining downside protection at this point. Thankfully, if you decide to “step-down” and rotate out of BJAN and into BOCT, for example, the upside cap is still super attractive with BOCT at 28.45%. So, if SPY recovers over the next 12 months, you could recoup all of your losses and potentially show gains too.
Note, you also have the option to sell your three Buffer ETFs now, take the losses and then swap into SPY (or another index-based ETF), with no downside protection at all. With this strategy, you do not cap your upside return potential, assuming SPY recovers. This strategy could appeal to a more aggressive investor who could “stomach” additional losses if SPY continues to decline. A purchase of SPY obviously has no downside protection, but it offers unlimited upside potential.
A swap out of the three holdings and into one of the October series Buffer ETFs would likely make more sense for conservative or moderate-risk investors. This move would provide some additional downside protection, but still allow the potential to recoup losses over the coming 12 months.
- How far has the reference asset (SPY) declined and how have the Buffer ETFs performed relative to the reference asset?
As mentioned earlier, all three Buffer ETFs that you own have declined less than the reference asset. UJAN has performed the best, relatively speaking, losing 7.59%. PJAN is down 11.45% and BJAN is off 16.89%. The reference asset (SPY) has tumbled 24.8%. So, all three Buffer positions have held up relatively well and you should consider a sale/swap into the October Buffer series that offers a better chance to recoup your losses over a longer time horizon. Thankfully, all the Buffer ETFs in the October series offer compelling upside caps.
It’s also worth noting that if you’re thinking of rotating into a different Buffer series, be mindful of where the reference asset is trading relative to the Buffer ETF. For example, if the reference asset is only slightly below your downside buffer level, all it needs to do is recover into the buffer “zone” at the end of the outcome period, and your ETF will then recoup all of its losses. However, if the reference asset is trading significantly below the ETF, and well below the buffer zone, as is the case currently for BJAN, it would have to recover a lot to get back to the buffer level for you to recoup your losses. SPY would have to recover over 20% in three months for BJAN to get back in its buffer zone by the end of the outcome period.
Anyway, be aware of the performance difference of the reference asset and your Buffer ETF, and know what percentage the reference asset would need to recoup to be within the buffer zone by the end of the outcome period. This information could help influence your decision to rotate out, or not.
- How much time remains in the outcome period of the Buffer ETFs?
You only have 92 days remaining in the outcome period for the January series you own, so it doesn’t give you much time to recoup your losses. You need the reference asset to rally quickly to get back into the buffer zones of your current holdings. For your Buffer ETFs that are trading well below the buffer zone, BJAN, for example, you may decide it’s unlikely you’ll recover enough in three months to get into the buffer zone, which would make stepping-down and rotating into the October series perhaps an easier decision, at least for BJAN. Note, UJAN is still trading within its buffer zone and still offers more downside protection, so you could decide to hold it. But again, UJAN has also significantly outperformed the reference asset, so it provides you with the best potential to outperform (assuming SPY recovers), if you rotate now to a new Buffer ETF series with a higher cap. - What is your risk tolerance? Are you a conservative, moderate, or aggressive investor?
If you have a very low tolerance for risk, you are likely not comfortable with the losses you’re seeing in two of your three Buffer holdings. BJAN and PJAN have both lost quite a bit on a percentage basis, but have still nicely outperformed the reference asset. Still, your low tolerance for risk may make you uncomfortable. UJAN is showing a much smaller loss and still offers more downside protection (-5% to -35%), so this position is not a big concern for you. If you are a very conservative investor, you will likely want to rotate out of BJAN and PJAN to get some additional downside protection from current levels, just in case SPY declines even further before the next reset date.
If you are a moderate or aggressive investor you may want to capture the outperformance you’ve had (you’ve lost quite a bit less than the reference asset) and rotate into the new October series that offers higher caps and more time to recover your losses (12 months). If you are somewhat aggressive, you could swap into BOCT, which offers the least amount of additional downside protection, but also the highest cap. Or, you could swap into SPY, with no protection at all, but unlimited upside potential. If you are a moderate-risk investor, you may decide to rotate into POCT since it offers another 15% of downside protection, but still plenty of upside potential (20%+) over the next 12 months. - Are your positions held in a taxable account? If so, is it advantageous to sell and harvest tax losses?
I think it’s usually a good idea to harvest tax losses whenever you can, so you may want to rotate out of all your Buffer ETFs (January series) that are currently showing losses. A tax-loss carryforward can be valuable and can help offset realized gains indefinitely (can be “carried forward” to future tax years). Still, I wouldn’t let your tax situation alone influence your decision since there are so many other factors to consider. However, if you have realized gains that you took earlier in the year, and you want to help offset those gains, then you likely will want to capture losses before the end of the year and rotate into a different Buffer series. Note, in tax-deferred accounts, where there is no reporting of gains or losses to the IRS, this topic is moot. - What is your short-term opinion of the direction of the reference asset (SPY)? Do you fear SPY could decline further and finish even lower at the end of the outcome period? Or, do you think SPY could recover quickly?
Your opinion as to the direction of the reference asset in the coming months could greatly influence your decision to hold or rotate out of the January series that all currently show losses. If you fear a further decline in the reference asset, for whatever reasons, you may be inclined to sell now and rotate into a new Buffer series that offers additional downside protection. UJAN still has additional downside protection, but your other two holdings don’t offer any more protection. So, if you think SPY may continue to decline in the remaining few months of the outcome period, you might want a fresh buffer and a swap could make sense.
On the other hand, if you think the selling has exhausted itself and the reference asset is poised to recover quickly, you would likely want to at least sell your two positions that offer the most protection (PJAN and UJAN), and rotate into the October series that offers 9% protection, but has the highest upside cap. Sure, you need to have the necessary risk tolerance to make this move, but it would allow for the most upside potential if you’re correct with your market call, and it would also provide you with some additional downside protection too. - What are the starting upside caps for the three Buffer ETFs (BOCT, POCT and UOCT) that are now resetting on October 1, 2022? Are the upside caps attractive enough to consider rotating into the October series?
The upside caps for the October series are very attractive. They offer some of the highest upside caps since Buffer ETFs were first launched in 2018. So, all three of the October Buffer series ETFs are worth considering. POCT might be the sweet spot if you are a moderate-risk investor. It offers 15% downside protection, in case the reference asset continues to decline, but it also offers a high upside cap (20.72%) that would allow you to recoup losses if SPY rebounds strongly over the next year. The high upside caps of the October series could influence you to rotate out of the January series now and into the October series.
Please recognize that options market pricing is hyper-efficient, intra-outcome period, for Buffer ETFs. So, despite the higher caps for the October series, staying put in the January series wouldn’t necessarily be a “bad move.” You don’t have to rotate or step-down in a declining market, but if you are looking to possibly capitalize on a potential opportunity, and it fits your specific outlook and time horizon, then an intra-outcome trade could indeed be attractive.
There are many factors to consider when deciding if it makes sense to step-down and rotate into a new Buffer series in a declining market. Weigh your answers to the questions in this chapter carefully to decide which course of action would make the most sense for you.