Buffer ETFs 101: A Beginner's Guide to Getting Started

Buffer ETFs are a type of exchange-traded fund that aims to provide a "buffer" or a protected zone against losses in a portfolio.

They work by investing in a combination of stocks and options to generate income and reduce volatility.

One key benefit of Buffer ETFs is that they can provide a way to earn income without taking on excessive risk.

To get started with Buffer ETFs, you'll need to understand the different types available, such as those that focus on income generation or those that aim to reduce volatility.

Some popular Buffer ETFs include those offered by Invesco and Global X, which have gained significant traction in the market.

These ETFs often have a variety of underlying assets, such as stocks, bonds, and commodities, which can help to diversify a portfolio.

Buffered ETFs are designed to provide a safety net against market downturns.

They typically have four layers: buying a call option on the reference index, purchasing puts to get the downside buffer, selling puts to offset the expense of buying those puts, and selling a call option to cap the return.

Common downside buffer levels are 10% and 20%, which means there's a cushion on the first 10% or 20% declines of the reference index.

The upside cap is determined at the start date and depends on the options market at that time.

FLEX Options are only on the price returns of the reference asset, meaning no dividend income on the underlying index.

A buffered ETF's payoff profile is influenced by the reference index returns and the terms of the FLEX Options at the start of the outcome period.

The rate of return for a buffered ETF depends on two factors: the underlying index return and the terms of the FLEX Options at the start of the outcome period.

Investors can consider a buffered ETF a "buy-and-hold" investment, but it's also possible to actively trade them.

The issuers of buffered ETFs assume investors hold the ETF for the full one-year investment period.

Buffered ETFs can be used in a number of ways, including as an equity diversifier or to move cash 'off the sidelines' while mitigating risk.

They have a defined outcome period, or expiration date, which investors must consider after it ends and the potential market conditions at that time. The risk mitigation zones can be structured, but the corresponding upside cap may be different over time.

A vast number of variations of buffered products have been released over the last few years, with both conservative and aggressive options available to fit any risk profile.

Investors must do their due diligence and understand the trade-offs between upside potential and downside risks before investing in a particular strategy.

Common downside buffer levels for ETFs in the market are 10% and 20%, meaning there is a cushion on the first 10% or 20% declines of the reference index, respectively.

The upside cap, which is determined at the buffered ETF start date, depends on the options market at the time the hedging takes place.

The FLEX Options used in buffered ETFs are only on the price returns of the reference asset, meaning no dividend income on the underlying index.

Buffered ETFs are a type of investment product that can be a bit tricky to understand, but don't worry, I'm here to break it down for you.

They're designed to provide a buffer against losses, typically 10% or 20%, and a cap on gains, which can be different from year to year. This means that if the market goes up a lot, the ETF won't enjoy gains beyond a certain point.

The returns of a buffered ETF are primarily driven by the returns of the underlying asset, usually the S&P 500. The direction and scale of the returns matter, and if the market breaks through the upside cap, the ETF will flat-line and receive no further upside returns.

The risks of buffered ETFs lie in the extremes - if the market is up a lot, the ETF won't enjoy gains beyond a certain point, and if markets sell off too much, the ETF is exposed to open-ended losses.

Here are some key points to keep in mind when considering a buffered ETF:

By understanding these key points, you can make a more informed decision about whether a buffered ETF is right for you.

There are many variations of buffered products available, so investors must do their due diligence to understand the trade-offs between upside potential and downside risks.

A vast number of buffered ETFs have been released over the last few years, offering variants to fit just about any risk profile, from very conservative to very aggressive.

Investors should consider what to do after the outcome period ends and the potential market conditions at that time, as the risk mitigation zones can be structured but the corresponding upside cap may be different over time.

Common downside buffer levels for ETFs in the market are 10% and 20%, meaning that there is a cushion on the first 10% or 20% declines of the reference index, respectively.

Investors have been flocking to buffered ETFs, which offer a relatively certain way to navigate uncertain markets.

Clearly, the appeal of buffered ETFs is rooted in their ability to shelter investments from losses, up to a point.

The uncertainty surrounding equities, bonds, and the global economy has driven people to seek out the relative certainty of buffered ETFs.

Given this uncertainty, it's no surprise that the assets under management (AUM) for buffered ETFs have grown significantly.

The number of buffered ETFs available to investors has also increased, providing more options to choose from.

These options-based ETFs have become increasingly popular, with a growing number of funds to select from.

If you're looking for the best Buffer ETF options, consider the Vanguard FTSE Canada All Cap Index ETF, which offers a broad diversification of Canadian stocks with a low MER of 0.11%.

For a more focused approach, the iShares S&P/TSX 60 Index ETF is a popular choice, tracking the 60 largest Canadian stocks with a MER of 0.18%.

The BMO Equal Weight Index ETF is another option, providing equal weights to each stock in the index, reducing the impact of individual stock performance.

The MER of the BMO Equal Weight Index ETF is 0.20%, making it a slightly more expensive option compared to the Vanguard FTSE Canada All Cap Index ETF.

Buffered ETFs are a type of investment strategy that involves buying and selling options to create a cushion against market downturns.

The strategy typically involves four layers: buying a call option, purchasing puts, selling puts, and selling a call option to cap returns.

Common downside buffer levels for ETFs are 10% and 20%, meaning there's a cushion on the first 10% or 20% declines of the reference index.

The upside cap is determined at the start date and depends on the options market at that time.

Active funds offer a more hands-on approach, but they can be more expensive than passive funds, which are often preferred by investors who want to keep costs low.

For some investors, the simplicity of a single ETF is a major advantage, but for others, a fund-of-funds solution provides a diversified portfolio in one easy-to-manage package.

The fund-of-funds approach can be especially appealing to investors who want exposure to a variety of buffered ETFs without having to make individual buying and selling decisions.

Investors who prefer to make their own decisions about individual ETFs may not see the value in the additional layer of management fees for a fund-of-funds solution.

ETFs are traded on major stock exchanges, just like individual stocks. This allows investors to buy and sell ETFs throughout the day.

An ETF can track a variety of asset classes, including stocks, bonds, commodities, and currencies. Some ETFs focus on a specific sector or industry, like technology or healthcare.

Index ETFs track a particular market index, such as the S&P 500 or the Dow Jones Industrial Average. This means their performance is closely tied to the underlying index.

ETFs typically have lower fees compared to actively managed mutual funds. In fact, some index ETFs have expense ratios as low as 0.03%.

Buffered ETFs use a combination of options strategies to provide a buffer against losses and a cap on gains. This involves buying call options, purchasing puts, selling puts, and selling call options to create a cushion against market downturns.

A buffered ETF typically has four layers to its strategy. The first layer involves buying a call option on the reference index for the future maturity date, usually 12 months ahead. The second layer involves purchasing puts for the outcome period end date on the reference index to get the downside buffer.

Common downside buffer levels for ETFs in the market are 10% and 20%, meaning there's a cushion on the first 10% or 20% declines of the reference index, respectively. The upside cap, determined at the buffered ETF start date, depends on the options market at the time the hedging takes place.

The FLEX Options used in buffered ETFs are only on the price returns of the reference asset, which means no dividend income on the underlying index. The remaining upside cap and downside buffer move real-time intra-period depending on market performance of the reference index and corresponding ETF share price.

Buffered ETFs can be a valuable tool in managing your portfolio, particularly during times of market uncertainty. A significant number of variations of buffered products have been released over the last few years, offering a range of options to suit different risk profiles.

Investors can use buffered ETFs to reduce volatility and de-risk equity positions, helping to protect against significant market events. Since 1957, calendar year returns for the S&P 500 have been positive 45 times, and negative 18 times, with full year negative returns occurring 29% of the time.

Using a buffered ETF can help mitigate the impact of these negative returns, allowing you to maintain a level of equity upside while reducing downside volatility. A buffer can provide a level of loss mitigation and upside potential in portfolios.

According to the Federal Reserve, there is more than $19 trillion in assets held in money market funds, checking accounts, or savings accounts/CDs, which could be put to work with a more conservative approach. This is a significant amount of cash that could be invested with the help of buffered ETFs.

Here are some potential use cases for buffered ETFs in your portfolio:

These use cases can help you make the most of your investment portfolio, especially during times of market uncertainty.