A New Way for ETF Investors To Hedge Market Risks

To help hedge against sudden turns in the U.S. equities market, the fund purchases U.S. exchange-listed protective “out of the money” put options in the 0% to 30% out of the money range on stock indices each month.

A put option provides the buyer the right to sell the underlying index to the put seller at a specified price within a specified time period. In the event of a decline in the underlying index, the put may help reduce the downside risk. Consequently, the put option becomes more valuable as the underlying market weakens relative to the strike price.

Traders who write put options have essentially sold the right to another investor to sell shares at an agreed-upon price. On the other hand, the buyer has purchased the chance to sell stock to the put writer. In other words, the party who writes puts acts as an insurance provider for the portfolio’s downside but gains access to premiums, or income.

However, if the market rises over the specified period, the cost of the option might be lost. Consequently, the strategy may underperform during strong rallies.

Additionally, since the put options generate premiums or income, TAIL investors may also have access to an alternative yield-generating asset. Many investors are stretching for yield and taking on risk in a low-interest-rate environment, and this tail risk strategy may provide a good alternative.

For more information on new fund products, visit our new ETFs category.