New ETF Offering 100% Downside Protection Debuts on Wall Street
The new 'buffer ETF' launched by Innovator Capital Management is designed to limit losses during market selloffs.
The Innovator U.S. Equity Principal Protected ETF (NYSE Arca: TJUL), the first-ever ETF to offer investors 100% downside protection, began trading yesterday.
Buffered exchange-traded funds (ETFs), also known as defined outcome ETFs, are designed to offer investors protection against losses in a market downturn. Buffered ETFs accomplish this without holding a company’s shares. Instead, they utilize a package of derivatives consisting of flexible exchange or flex options.
Per the Financial Times, here’s how a buffered ETF tracking the S&P 500 (SPX) might use flex options to accomplish its goal:
- The ETF will first buy a call option on the index, typically for 12 months, allowing it to buy the index at today’s price. It will also buy a put option to provide protection, giving it the right to sell the index in a year, again at current price levels.
- Given that the downside protection was not 100% before the new TJUL ETF, the ETF was able to recoup a little of this outlay by selling some put options. For example, if an ETF protects investors against the first 15% of any loss, it could buy puts with a strike price of $100 and sell puts at a strike price of $85.
- To balance the books, the ETF will then sell call options set at a level necessary to generate the premium income that offsets the cost of buying the protection.
The buffer ETFs also come with a gains cap that can fluctuate over time, per the market’s volatility. For example, the January 2021 issue of the Innovator S&P 500 Power Buffer ETF (NYSE Arca: PJAN) offered investors 15% downside protection against any loss incurred over the subsequent 12 months, while capping investor gains at 9.75%.
While the concept of buffered ETFs has been around since 2018, the Innovator U.S. Equity Principal Protected ETF is the first of its kind to offer 100% protection against losses.
The TJUL ETF, which tracks the S&P 500 index, offers investors a 100% buffer against losses over two years, along with an upside cap of 16.62%.
Graham Day, chief investment officer at Innovator, commented on his firm’s new ETF, stating:
“If we look at the insurance and structured-note world, we find that there is far more demand for products that give you some equity upside, but with 100% downside protection built into the products. That’s what we are going after with this Defined Protection ETF — to, for the first time, give investors access to the equity markets, but with a 100% buffer built into the product.”
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