Understanding How Buffer ETFs Work for Your Portfolio

Buffer ETFs are a type of exchange-traded fund that protects your portfolio from market downturns. They work by investing in a combination of stocks and options.

A buffer ETF's primary goal is to limit losses during a market crash, but it's not a guarantee of profits. This is achieved through the use of options, which give the fund manager the right to buy or sell a stock at a predetermined price.

Buffer ETFs typically have a "buffer" or "cap" that limits losses to a certain percentage, usually between 5% to 20%. This buffer is usually funded by selling options to investors.

Investors can choose from different types of buffer ETFs, including those that focus on specific asset classes, such as stocks or bonds.

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Buffer ETFs are a type of defined outcome ETF that works differently from covered call strategies. They aim to offer investors a pre-defined set of outcomes over a defined period, typically 12 months.

The lifecycle of buffer ETFs is crucial, with options expiring monthly or quarterly. This means that investors must invest right at the beginning of the roll period to access the full potential upside.

A buffer ETF with a lifecycle from 1 March 2024 to 28 February 2025 could aim to limit losses over the period to 10%, capping the upside at 15%. Any market movements after the start date will alter the potential outcome of the ETF.

Some issuers are addressing this issue by offering laddered products, allowing more flexibility for investors to exit and enter the products. For example, First Trust offers this in the US but has yet to add it to its European ETF suite.

Buffer ETFs tend to be more expensive than other options-based strategies and carry different risks. The strategy is complex, and investors will need to familiarize themselves with the product's mechanics.

Here are some examples of buffer ETFs listed in Europe:

Buffered outcome ETFs are designed to provide a consistent income by investing in a portfolio of stocks and selling call options on a portion of those stocks. This strategy is often used by investors looking for a more predictable income stream.

One of the key characteristics of a buffered outcome ETF is that it sells call options on a portion of the underlying stocks. This gives the buyer the right to buy the underlying stock at a specific price, known as the strike price, on or before a certain date.

The call option premium received by the ETF is a key source of income for the investor. If the underlying stock does not reach the strike price by the agreed date, the call option will expire worthless, and the ETF will keep the premium.

However, if the underlying stock hits the strike price, the ETF will sell the stock at the approved price and still keep the premium as income. This can result in a loss of potential gains if the stock price increases significantly before the deadline.

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Here are some examples of covered call ETFs that have launched in Europe:

Note that the performance of these ETFs can vary, and investors should carefully consider the risks and fees associated with each fund before investing.

Buffered ETFs can be a great fit for investors who want to reduce volatility in their portfolios. They can help protect against significant market events.

For those with a domestic equity exposure, buffered ETFs can be used to reposition a portion of it and help reduce downside volatility with a buffer. This can also maintain a level of equity upside.

If you're looking to diversify your traditional allocation, buffered ETFs can help increase upside to a cap while preserving risk targets.

A share of cash balance can also be repositioned to potentially help maintain a level of protection and upside participation.

The S&P 500 index has had negative returns for the year 18 times since 1957, and full year negative returns have occurred 29% of the time.

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Buffer ETFs come with some caveats. Cost is one, with an average expense ratio of 0.77%, more than the typical 0.59% fee for actively managed diversified U.S. stock ETFs.

You need to time your purchase, too. It's best to buy these funds within a week of the start of its 12-month stretch, just when the fund rebalances.

The buffer and cap will shift depending on the broad market's moves and the fund's net asset value each day if you don't buy at the start of the outcome period.

You can get out at any point, but keep in mind that the buffer and the cap on any given ETF apply to its full outcome period.

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ETFs use options to create a buffer against losses.

The buffered ETF investment strategy typically involves four layers: buying a call option, purchasing puts, selling puts to offset the cost of the puts, and selling a call option to cap the return.

Common downside buffer levels for ETFs in the market are 10% and 20%.

The upside cap, which determines the maximum potential return, depends on the options market at the time the hedging takes place.

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ETFs are a type of investment vehicle that tracks a specific index, sector, or asset class, such as the S&P 500 or gold.

They are often referred to as "index funds in disguise" because they allow you to invest in a broad range of assets with a single trade.

ETFs trade on an exchange like stocks, making it easy to buy and sell them throughout the day.

You can buy and sell ETFs through a brokerage account, just like individual stocks.

Most ETFs have a low expense ratio, which means you pay less in fees compared to actively managed mutual funds.

ETFs also offer tax efficiency, as they don't have to sell securities to meet shareholder redemptions, which can trigger capital gains taxes.

Many ETFs have a low minimum investment requirement, making them accessible to investors with smaller amounts of capital.

Some ETFs also offer a wide range of investment options, including international stocks, bonds, and commodities.

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If you're new to ETFs, it's essential to understand the different types of options available to you.

One of the most popular options is the call option, which gives you the right to buy an underlying ETF at a specified price.

A put option, on the other hand, gives you the right to sell an underlying ETF at a specified price.

You can also use ETF options to hedge against potential losses or to speculate on price movements.

Buying a call option can be a great way to gain exposure to an ETF without having to buy the underlying shares outright.

For example, if you buy a call option on the SPY ETF, you're essentially betting that the price of the ETF will rise above the strike price.

The strike price is the price at which you can buy or sell the underlying ETF, and it's a crucial factor in determining the cost of an option.

You can choose from various strike prices and expiration dates to suit your investment goals and risk tolerance.

It's also worth noting that options can be used to create complex trading strategies, such as spreads and collars.

Investing is more dynamic than ever, and without the right tools, many investors fall short of their goals.

Today's markets are uncertain, making it challenging to navigate.

Buffered ETFs offer a flexible and risk-managed approach to investing.

These products come with downside buffers and upside caps, allowing investors to maintain exposure with a defined outcome for multiple scenarios.

Halo believes that the benefits of buffered ETFs should be available to all investors.

The company's goal is to make these products transparent, efficient, and accessible with real-time analytics.

This approach can help investors feel confident they will be financially prepared for the future.

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