A variety of exchange traded funds use options strategies paired with equity exposure to offer investors an efficient combination of capital appreciation potential and hedging.
The newly minted WisdomTree Target Range Fund (GTR) could prove to be one of the more compelling concepts in this group. GTR debuted last week, but investors seeking the highly sought-after marriage of upside potential with downside potential ought not to focus on GTR’s age, or lack thereof. Rather, they should evaluate how the fund could benefit their portfolios.
Actively managed, GTR provides exposures comparable to the “TOPS® Global Equity Target Range Index (TOPSGB) (the “Index”), a systematic strategy that buys options that are 15% in-the-money and sells call options that are 15% out-the-money, but it will not match the Index’s returns due to the amount and timing of assets that flow in and out of the Fund,” says Bradley Krom, WisdomTree’s director of research.
GTR’s equity exposure is sourced through familiar ETFs spanning domestic large- and small-cap equities as well as international stocks, both developed and emerging markets. Those ETFs are the SPDR S&P 500 ETF Trust (SPY), the iShares Russell 2000 ETF (IWM), the iShares MSCI Emerging Markets ETF (EEM), and the iShares MSCI EAFE ETF (NYSEArca: EFA).
While those are basic equity funds, GTR reduces traditional equity risk and diversifies portfolios with the use of options. Part of GTR’s allure is that its options strategy is straightforward to the point that even novice options can easily comprehend how the new ETF functions.
“The WisdomTree approach involves purchasing one-year call options on each underlying ETF at the start of the year that are 15% in-the-money and selling one-year call options that are 15% out-of-the money—while the remainder of the Fund is allocated to a collateral account invested in fixed income instruments,” adds Krom. “Assuming the options cost 15 cents to acquire these 15% in-the-money options, approximately 85 cents of every dollar invested in the Fund is in the collateral account.”
GTR charges 0.70% per year, and while that’s higher than a basic pure beta fund, it’s a fair expense ratio in the realm of options-based strategies. Additionally, GTR has levers for keeping costs low, which can benefit investors over time.
“To help reduce costs, the Fund sells higher strike call options. This is done on a per exposure basis, i.e. for each of the four ETFs held in the portfolio,” notes Krom.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.