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In recent years, advisors and investors looking for higher levels of equity income than are typically found with straight dividend stocks and funds have increasingly turned to options-based strategies, including exchange traded funds.
Perhaps not surprisingly, the popularity of options-based income in ETF form was built in part against the backdrop of rising interest rates, which obviously punished fixed income returns. That highlighted the allure of covered call ETFs, which are not nearly as rate-sensitive as standard bonds or fixed income funds.
Speaking of covered calls, that’s the primary options-selling strategy married with the ETF wrapper, but there are some put-writing funds on the market. That universe increased in size with last Friday’s debut of the Innovator Equity Premium Income – Daily PutWrite ETF (SPUT). In simple terms, SPUT generates income by selling daily put options on the S&P 500.
What Makes SPUT Unique
One of the advantages of an options-selling strategy such as SPUT is that investors have exposure to sources of returns: interest income and the income earned from selling options, the latter of which can increase as market volatility does the same. To its credit, the newly minted ETF features some attributes that are unique relative to old guard counterparts.
“Institutions' use of put options for risk management is a source of upward pressure on the price of puts,” according to Innovator. “For a put and a call with the same characteristics in normal market conditions, the put tends to have a higher price. SPUT seeks to capitalize on this dynamic by selling 1-day puts that have a relatively low probability of incurring a loss.”
The use of one-day options is novel in the options ETF realm as most of SPUT’s older rivals use one-month options. Daily options are arguably casinos within a casino meaning it’s incredibly difficult for retail market participants to get these trades right. SPUT ameliorates that scenario while providing a mousetrap that’s potentially superior to covered call ETFs.
“Put-writing strategies involve selling cash-secured put options on stocks or indexes” adds Innovator. “Unlike covered calls, which cap upside potential, put-writing allows for full market participation because investors keep the option premium if the stock stays above the strike price.”
Novice options investors often overlook the point that selling calls is not a bullish strategy. Thus, upside with covered calls is limited. Conversely, selling puts, as SPUT does, IS bullish. As a result, SPUT offers the potential for more upside than covered call rivals.
More SPUT Perks
The clear, robust and non-rate-sensitive income proposition offered by SPUT coupled with its upside potential relative to competing strategies make the new ETF appealing to income-hungry clients, but there’s more to the story.
That includes downside protection, which could lead to a stronger risk-adjusted return profile for SPUT than competing ETFs.
“Both covered call and put-writing strategies generate income from options premiums, but put-writing offers a unique benefit: the premium collected acts as a buffer against losses, similar to covered calls, but the key difference is that put-writers aren’t giving up future upside,” concludes Innovator.
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