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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 generally not 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 the 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 potential advantages of an options-selling strategy such as SPUT is that investors have exposure to sources of returns: interest income through T-Bills and the income earned from selling options, the latter of which may 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 seeks to ameliorate that scenario while structuring a strategy with the potential to generate higher income than 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 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 income proposition offered by SPUT coupled with its upside potential relative to competing strategies is designed to make the new ETF appealing to income-hungry clients, but there’s more to the story.
“Both covered call and put-writing strategies generate income from options premiums, but put-writing offers a unique benefit: the premium collected may provide a shallower drawdown, similar to covered calls, but the key difference is that put-writers aren’t giving up future upside,” concludes Innovator.
Put: An option contract that provides the buyer the right (but not the obligation) to sell a specified amount of an underlying security at a predetermined price. Call: An option contract that provides the buyer the right (but not the obligation) to buy a specified amount of an underlying security at a predetermined price. Covered Call: A strategy that involves holding a long position in a security and selling a call option on that security in seeking to realize additional income from the option premium.
The Fund seeks to provide current income while providing the potential for capital appreciation. The Fund’s income is expected to be received primarily from its purchases of Equity-Linked Notes (ELNs) that implement a put-write option strategy. The ELNs provide the Fund with monthly distributions comprised of premiums generated from selling single-day expiration, out of the money put option contracts on the S&P 500 Price Return Index (SPX) that provides exposure to approximately 100% of the Fund’s assets. The Fund also expects to receive income generated by its investments in U.S. Treasuries and dividends, if any, from its investments equity securities primarily comprising components of the Solactive GBS United States 500 Index (U.S. Equity Index). The Fund’s investments in equity securities also seek to provide the potential for capital appreciation.
The Fund will also be subject to the downside performance of the U.S. Equity Index and SPX through its respective holdings in equity securities and ELNs. The Fund’s monthly income payments to investors may not be sufficient to offset any such losses on a total return basis. There can be no guarantee that the Fund will be successful in its objective to provide current income while maintaining the potential for capital appreciation.
Equity-Linked Notes Risk. Investing in ELNs may be more costly to the Fund than if the Fund had invested in the underlying instruments directly. Investments in ELNs often have risks similar to the underlying instruments, which include market risk. In addition, since ELNs are in note form, ELNs are subject to risks of debt securities, such as credit and counterparty risk, including the risk that issuers and/or counterparties will fail to make payments when due or default completely. Should the prices of the underlying instruments move in an unexpected manner, the Fund may not achieve the anticipated benefits of an investment in an ELN, and may realize losses, which could be significant and could include the Fund’s entire principal investment. However, the Fund’s exposure to losses in its investments in the ELNs is limited to its principal investment in such ELNs. Investments in ELNs are also subject to liquidity risk, which may make ELNs difficult to sell and value. A lack of liquidity may also cause the value of the ELN to decline. In addition, ELNs may exhibit price behavior that does not correlate with the underlying securities.
Put-Write Risk. Put option contracts may be subject to volatile swings in price influenced by the underlying reference asset. Although the Fund receives premiums on the put option contracts written by the ELN, the losses experienced by the Fund if the level of SPX falls below the strike price may outweigh Fund gains from the receipt of the option premiums. With respect to the Fund’s investment in ELNs, the Fund’s returns are limited to the amount of option premiums it receives. Additionally, market conditions may negatively impact the amount of premiums received from selling put-write option contracts or impact the selected strike price of the option contracts, subjecting the Fund to more risk of loss.
Put-Write Index. The ELNs in which the Fund will invest will provide leveraged exposure to an index or indices that implements the options strategy and the performance of a portfolio of the daily put contracts (Put-Write Index). The Put-Write Index sells one-day maturity put option contracts on SPX on a daily basis that generally seeks to provide income through premiums received. The Put-Write Index subjects the ELNs, and therefore the Fund, to the risk of loss associated with price decreases of SPX below the strike price. If the Put- Write Index experiences any losses based off the price movements of SPX, as a result of the 100% notional value utilized by the Put-Write Index, the losses incurred by the ELNs the Fund invests in will be greater than those experienced by SPX.
While the Put-Write Index seeks to minimize the risk associated with the written put option contracts, the Put-Write Index and ELNs subject the Fund to risk of loss, including the risk that the Fund may lose the entirety of its principal amount invested in an ELN.
Investing involves risk. Principal loss is possible. Innovator ETFs are distributed by Foreside Fund Services, LLC.
The Fund’s investment objectives, risks, charges and expenses should be considered carefully before investing. The prospectus and summary prospectus contain this and other important information, and it may be obtained at innovatoretfs.com. Read it carefully before investing
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