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Had Zoom meeting with our FA yesterday and needless to say we are down
He said we might consider using Innovator ETFs for part of our equity portion—
They are option-using to buffer the downside and cap the upside
Anyone familiar with that model?
Think they have a place in a retired couple’s portfolio?
I just looked it up. At least with their S&P 500 funds it’s all a synthetic options play without owning the underlying security. It reads very similar to structured products that are shorter term auto renewing annually. Probably better tax treatment than structured products but at 0.8% per year it’s probably cheaper to go with structured notes at 3% for 7 years to get the same outcome. Cap your upside with some downside protection. If you are long term you could just buy S&P and hold, cheaper and much more transparent. Some of the structured notes have uncapped upside with downside protection but they are unsecured debt to the issuer fwiw
I don’t need fancy ETFs to get me where I’m going especially with capped upside
Yeah, any FA who's suggesting NOW is the time to get out of equities into these hedging products doesn't know what he/she is doing. Depending on what the account is for (retirement?) you generally want to take a long-term view of the holdings, the markets have been down for quite some time, buy stocks now while they're cheap and reap the rewards for years to come.
The subject ETF's hold the underlying by means of an in-the-money call-option. Then the possible upside is allowed but capped with a call-write. The possible downside uses a put-spread such that there are no losses until after a buffer is passed. However, large losses are possible like during historic crashes.
Probably, it takes both the out-of-the-money call-write and the out-of-the-money put-write to pay for the at-the-money put-purchase
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It sounds close to the old CDs linked to the market we used to do ourselves
I have some old instructions I once posted here
these rarely pan out better than a cd on steroids , not a market investment ..
i used to make my own index linked investments when rates were higher ..
i could lock in whether i wanted to participate in the s&p 500 and either guarantee i would not lose a penny . or i could guarantee i get a certain amount of gain as a min while participating in the s&p 500 ...
in any case it is never close to a actual investment in the s&p 500 . i have done this for years ... it produced returns that were no where near a real market investment .
i used to do it with cd's when rates were higher creating index linked cd's ... they are donre the same as the insurers do them with fixed income as a base .
this is how i did it , but don't go by the numbers anymore , i did this quite a while ago but saved the way to do it .
An EIA is an insurance contract that theoretically offers the buyer the opportunity to participate (to some extent) in equity market performance while guaranteeing a minimum payout at the end of the policy guarantee period.
The extent to which the buyer participates in equity market performance typically varies year to year as does the minimum guaranteed crediting rate (AKA interest rate paid on the policy). This has proven to be a tantalizing pitch for many conservative investors. The problems with these policies are that you have little control over how much you participate in the equity market; the policies typically have high early surrender fees and have surrender periods usually .
the internal expenses of these policies are quite high; you are exposed to insolvency of the issuer; the participation is typically limited to price changes in an equity index, with no compensation for dividends on the index; the participation in the index is capped at a predetermined level so that really big gains are truncated within the annuity structure; and the tax treatment of eventual distributions may be less than optimal.
How you can “roll your own” EIA, part 1:
By far, the simplest way to set up an EIA is to do it in an uncapped version. The simplest uncapped replication portfolio consists of a 1 year fixed income investment (such as a CD) and a call option on whatever equity index ETF you want exposure to. So let us assume you can buy a 1 year CD that yields (APY) 4%, you want exposure to the S&P 500, you have $100,000 to invest, and you want a minimum yield of 1%. To replicate an EIA, you would buy the following:
CD: You want $101k in a year, so you invest $101,000/1.04 = $97,115 in a 1 year 4% yield CD. In a year, the CD matures and you get $101,000, which is your desired minimum payout.
Options: Your CD purchase leaves you with $100,000 - $97,115 = $2,885. You take this amount and buy at the money 1 year call options on the S&P 500 index ETF (ETF symbol SPY). At the money means that the option exercise price is about equal to whatever the ETF sells for today. So with SPY trading at $137.93 as I write this in April 2008, we wish to buy April 2009 calls with a strike of $138. Such a thing doesn’t exist, so we will settle for the closest month we can get, which is March 2009. March 2009 calls (Symbol SFBCH) sell for $12 each and must be bought in contracts on 100 shares each, so you want to buy $2885/$1200 = 2.4 contracts, but must buy 2 contracts for $2400.
So you end up with a CD that will pay $101,000 in a year, $485 in cash, and options on 200 shares of SPY struck at 138. The options cover a notional amount of $138 X 200 = $27,600, so your “participation rate” in the index is 27,600/100,000 = 27.6%, meaning that you catch 27.6% of the appreciation of the S&P 500 through next March while bearing none of the downside. When the options are about to mature, you can sell them for cash, assuming the market has gone up and they are worth anything. Otherwise, you collect your $101,000 from the CD, have your $485 plus whatever interest it generated, and decide if you want to play this game again for another year.
Rolling your own, part 2:
Instead of having a small, uncapped participation in the index, you could have a larger participation but cap it at a given level. This is essentially what is done inside the EIA contract sold by most insurers. To replicate the EIA, you would buy the same CD as in the above example. However, the options portion would include:
1) Buy the at the money options on the index as in the above example
2) Sell out of the money options for the same expiration date and underlying ETF.
An example will be helpful:
Lets assume that you would be willing to cap your upside in return for a higher participation rate. That means you want to buy call options at the money ($138 strike) and sell call options at a strike that is about 10% higher ($152 strike). The $152 strike options currently trade for about $5.50 a share. So we buy:
4 contracts of the at the money options (SFBCH) for 400X12 = $4800
And we sell:
4 contracts of the 10% higher strike $152 (symbol SYHCV) and receive cash of $400X5.50 = $2,200.
Total out of pocket for the options is $4,800 - $2,200 = $2,600.
So you end up with a portfolio that consists of a CD that will pay you $101,000 in a year, $285 in leftover cash, and a package of options that gives you up to 10% of the upside on 400 X $138 = $55,200 worth of the S&P 500 index. Note that by capping your potential upside you have increased your participation rate to $55.2% of your $100,000, or double the uncapped version.
Yeah, any FA who's suggesting NOW is the time to get out of equities into these hedging products doesn't know what he/she is doing. Depending on what the account is for (retirement?) you generally want to take a long-term view of the holdings, the markets have been down for quite some time, buy stocks now while they're cheap and reap the rewards for years to come.
I would say the opposite. Yeah, the market is down but what exactly is on the horizon for the next year or two that makes you optimistic that stocks are going to rebound? Corporate earnings seem to be down, across the board, as inflation continues to rage and a lot of people are not spending on discretionary items, they are spending on necessities now. The good times ended with the regime change in Washington, whether people care to admit it, or not.
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