Embracing Complexity: Options Strategies See Greater Demand

One of the trends noticed during the ETF Exchange event in Las Vegas, Nevada, earlier this year was embracing complexity. Advisors are no longer hesitant to offer their clients alternative strategies for downside protection, income, or both via options-based strategies. While they should be reserved for those with the requisite knowledge of their mechanics, the advent of the exchange-traded fund (ETF) has made them more accessible. In today’s uncertain market environment, this embracing of the complex continues — as noted in previous webinars with Swan Global Investments and Fidelity Investments.Key Takeaways: Limitations in traditional balanced allocations during market drawdowns are driving broader adoption of options-based strategies. Specifically, those that help manage risk and generate alternative yields. The derivative income market has surged as investors seek call-premium yields without fixed-income duration or credit risk. Actively managed funds simplify execution by integrating institutional downside hedges and covered-call overlays directly within liquid ETF structures. See More: Harvesting Volatility: How FYEE Redefines Income in Today’s MarketWhen a 60-40 Portfolio Isn't EnoughThe classic 60-40 portfolio allocations, 60% of invested capital in stocks and 40% in bonds, were put to the test in 2022. Both stocks and bonds suffered drawdowns as the U.S. Federal Reserve hiked rates seven times that year to stave off inflation, which hit a 40-year high. With both asset classes suffering, it forced investors and advisors alike to rethink their allocations. This event helped to bring options-based strategies to the forefront as a viable alternative. With ETF products hitting the market, options-based strategies became accessible through the convenience of a flexible, liquid, and cost-efficient investment vehicle. During the webinar led by Swan Global Investments’ Rob Swan (COO and portfolio manager) and Marc Odo (director of research), the audience was asked a simple question: Do you use options-based funds? While 51% of the attendees said they did not, options-based funds were at least under consideration. Meanwhile, 16% noted that they used these products for hedging while 14% utilized them for income. 20% indicated they used these funds to achieve both hedging and income.To further highlight the surging demand, Swan Global also noted that options-based funds went from $20 billion and less than 100 products on the market a decade ago to now over $300 billion spread over about 900 products. One such product is the Swan Hedged Equity US Large Cap ETF (HEGD B). The actively managed fund uses an uncapped hedged equity approach that provides downside protection as well as participation in market upside. The flexibility of the fund is highlighted by its ability to slot into a portfolio to complement core equities exposure, serve as a bond surrogate, and as a vehicle to stay invested in the markets rather than remain in cash.Boomtime for Derivative Income ETFsThe webinar with Fidelity Investments further confirmed the increased demand for options-based strategies — or more specifically, derivative income ETFs. With a presentation from Eric Granat (portfolio manager/derivatives analyst), Ben Bingham (vice president, alternative investment strategist), and David Selbovitz (vice president, alternative investment strategist), the webinar asked attendees a similar question: What is your primary goal when considering an options-based strategy for client portfolios? 58% noted they used these products for income and greater yield while 27% used them to mitigate downside risk. Fidelity also made light of the boom in embracing the complexity of derivative income (covered call) ETFs. Their numbers showed that these funds went from $7 billion in 2020 to roughly $162 billion in present time, which constitutes an astounding growth rate of 23×. The primary reason for this boom is investor demand for more income or yield without the duration and credit risk inherent in traditional fixed income assets like bonds.FYEE's Rate Insulated Yield StrategyA product mentioned during the Fidelity webinar was the Fidelity Yield Enhanced Equity ETF (FYEE A). The fund is also actively managed, helping to reduce the complexity of using an options-based strategy to derive income. FYEE layers a sophisticated short-call option overlay over a diversified portfolio of high-quality U.S. large-cap stocks. Income is derived via option premiums, giving investors a source of yield that isn’t tied to changes in interest rates. This is especially pertinent in today’s market following the Fed’s first rate hike in three years. However, unlike bonds, FYEE income generation is less dependent on what the Fed will do next with regard to interest rate policy. Fidelity Investments will delve deeper into FYEE in a forthcoming Product Due Diligence session: The Right Derivative Income Strategy in Today’s Unusual Market Landscape. For more information on HEGD, visit the product site here. To get more information on FYEE, sign up for the forthcoming Product Due Diligence session on September 29. For more news, information, and strategy, visit ETFdb.