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Written by Stuart Chausse
Most investors find losses more painful than missing out on potential profits. One of the fastest growing segments of the ETF (exchange traded fund) market offers a potential solution. Since 2018, more than 160 buffer ETFs have been launched, attracting more than $30 billion in assets. Most buffer ETFs are offered by Innovator ETF (Innovatoretfs.com) or First Trust (Ftportfolios.com). BlackRock also recently launched its own iShares Buffer ETF.
Buffer ETFs allow investors to participate in stock market gains while providing a predetermined level of downside protection. “Buffers” typically protect against losses of 9%, 15%, or 30%, depending on the buffer series you own. Investors can customize their portfolio and choose how much protection they want to buy over a “defined outcome” period (usually he has 12 months).
Naturally, there are some costs associated with owning investments that provide downside protection. The “cost” of buffer ETFs means potential missed opportunities. Investment gains are limited to the subsequent 12 months. Still, most modern buffer ETFs that offer protection against an initial 15% loss have high upside caps of at least 15%, which is attractive over a 12-month period. 15% upside room and 15% downside protection provides a very attractive risk-reward opportunity in almost any market environment.
Buffer ETFs are complex. They don’t actually own the stock. Rather, they use options to track stock market performance.
dex (e.g. S&P 500). Most buffer ETF wrappers hold his four options contracts, and the ETF resets every 12 months (automatically rolls into the next 12-month period), with new downside protection and There is also a new upper limit. Buffer ETFs trade daily like individual stocks and other ETFs, but are designed to be held as long-term investments.
Buffer ETFs typically have three option tiers.
- ETFs use call options to purchase exposure to stock indexes.
- ETFs create downside protection (buffers) by purchasing put options.
- The ETF sells options to cover the cost of the protective put. ETFs typically sell both put and call options. A put option sets the amount of protection over the outcome period, and selling a call option “limits” the potential upside gain. These sales are necessary to offset the cost of purchasing the put options that provide protection.
Too complicated? You don’t need to understand the intricacies of the options market to profit from owning a Buffer ETF. The ETF issuer manages the options within his ETF wrapper, making buffered ETFs attractive to both beginners and experienced investors.
- You are worried about potential stock market losses.
- You are retired or pre-retired and want to participate in the stock market while reducing your risk.
- You are a conservative or medium-risk investor.
If you’re nearing retirement or have already retired and are worried about losing money in the stock market, the protection that buffer ETFs provide can give you some peace of mind and help you stay invested even in difficult markets.
Regardless of your age, if you’re a defensive investor who cares more about not losing money than hitting home runs, buffer ETFs will probably appeal to you. Many investors would rather have some downside protection and give up some upside than take a complete loss if the market crashes.
Buffer ETFs allow you to participate in the stock market, but with downside protection. Buffer ETFs trade with the same daily liquidity and transparency as stocks and other ETFs. Unlike many structured products such as annuities, there are no lock-up periods or surrender charges. There is also no credit risk. Finally, most buffer ETFs automatically reset after each 12-month performance period in a tax-efficient manner (with new protections and new upside caps), allowing you to hold them as long-term investments.
Buffer ETFs are not a perfect solution in every stock market environment. The risks are at an extreme. If you purchase a buffer series that provides 15% downside protection, but the market declines 25% during the resulting period, you will lose the difference, or 10% (plus the ETF’s advisory fees). Additionally, even if the market rises sharply from a correction or bear market, if the upside is limited, you will not be able to earn potentially high returns.
If you want to participate in the stock market rally but need downside protection, Buffer ETFs may be a great fit for your portfolio.
At the time of publication, Stuart Chausset and/or his clients held positions in the following buffer ETFs: BJAN, GAPR, PAUG, PJAN, PJUL, PMAR, PMAY, PNOV, POCT, PSEP. Holdings may change at any time. Under no circumstances does the information in this column constitute investment advice or a recommendation to buy or sell any security. Chausse can be reached at his Preservingwealth.com. or stuartchaussee@msn.com. pen
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