For many plain vanilla beta exchange traded funds, December 2018 has not been a December to remember. More to the point, the fourth quarter has been forgettable for traditional long equity strategies.
Various data points confirm as much, During the Christmas Eve trading day, just seven ETFs hit all-time highs, none of which was a traditional equity strategy. One of the seven funds delivering some holiday cheer to investors was the Cambria Tail Risk ETF (Cboe: TAIL).
TAIL tries to provide income and capital appreciation from investments in the U.S. markets while protecting against downside risk, according to a prospectus sheet. The active ETF will invest in cash and U.S. government bonds, and utilizing a put option strategy to manage the risk of a significant negative movement in the value of domestic equities, or more commonly known as tail risk, over rolling one-month periods.
TAIL’s tale of the tape is jaw-dropping at a time of struggles for U.S. equities. The fund is up nearly 10% over the past week, 16.51% this month and 9.34% year-to-date.
The Tale of TAIL’s Tape
“TAIL strategy offers the potential advantage of buying more puts when volatility is low and fewer puts when volatility is high,” according to Cambria. “While a portion of the fund’s assets will be invested in the basket of long put option premiums, the majority of fund assets will be invested in intermediate term US Treasuries.”
TAIL is actively managed. Tail risk refers to the normal distributions beyond three standard deviation, or more skewed distributions.
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.
“As the fund is designed to be a hedge against market declines and rising volatility, Cambria expects the fund to produce negative returns in the most years with rising markets or declining volatility,” according to the issuer.
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