We’ve talked before about how exchange-traded funds (ETFs) represent an efficient tool for gaining quick access to different types of assets or investment exposures. We’ve also discussed how options have become increasingly popular in recent years.
Today, we combine both topics and look at ETFs that include options. We see that it’s a growing segment of the ETF landscape.
ETFs with options give different returns to a stock portfolio
Options work a little differently than equities. Options expire — sometimes in the money, sometimes not — making their returns not “linear.” In addition, options can be:
- Held individually (single leg).
- Combined with other options (multi-leg).
- Combined with underlying equity exposures (overlay).
This can be used to create portfolios with different payoffs, like additional income or downside protection.
ETFs with options have been growing
As the data below shows, assets into option overlay ETFs have increased significantly since 2020, when markets experienced a sharp sell-off around the COVID-19 pandemic.
Prior to 2020, aggregate assets under management (AUM) in this category was around $5 billion. Today, those same types of strategies represent over $160 billion, with the bulk of assets invested in either enhanced income or hedging strategies (more on the differences later).
Chart 1: Assets in option overlay ETFs
In fact, when we look at annual ETF launches, we see that option overlay funds have generally represented between 20% to 30% of new equity ETF launches since 2019 (Chart 2).
Chart 2: Option overlay ETF launches
What option overlays are the most popular?
Not all option overlay strategies are the same. Options can be combined together in a portfolio to target a pre-defined outcome. In Chart 3, we group funds according to Nasdaq’s in-house fund taxonomy:
- Enhanced Income Strategies (Green) primarily try to increase income. This is typically done by writing, or selling, options to receive premium income in addition to long equity exposure (e.g., covered call like QYLD or put-write like WTPI).
- Hedging Strategies (Orange) primarily aim to protect downside while providing some upside participation via long put options, and short call options (e.g., traditional buffer funds like PDEC and FNOV, or 100% downside protection funds like TJUL).
- Enhanced Performance (Blue) try to outperform a benchmark through increased income (e.g., OVL, or SPYC).
As of March 2025, we tallied over 430 equity ETFs with options, representing over $160 billion in total AUM. However, as we can see below, the income and hedging strategies represent almost all of the total assets in the space.
Chart 3: Option overlay ETFs by strategic focus
How do they work?
Each overlay strategy is typically some combination of long and short positions in call and put options, all producing slightly different outcomes. The diagrams below show how the combination of stock exposure (diagonal line) and options exposures (“hockey sticks”) combine an indicative portfolio return profile that is “not linear” (the blue line is not straight).
Chart 4: Hypothetical payoffs of different types of option overlays
The diagrams above show how some of the popular overlay strategies work. Note that there is usually a trade-off to produce these returns. The blue line is sometimes above the diagonal stock returns (better), and sometimes below it (worse).
The benefits of each are also different:
- Covered call – generate income with limited upside.
- Protective put – fully protect downside but participate in upside.
- Traditional buffer fund – buffer downside (up to a certain point) and produce some upside equity participation.
- 100% downside protection (or collars) – similar to traditional buffer funds, except downside is fully protected.
A deeper dive into covered calls and protective puts
The first option-overlay ETF in the U.S. market was the Invesco S&P 500 Buy/Write ETF (PBP), which implements a covered call strategy on the S&P 500.
A covered call typically has two positions:
- Long equity exposure – simply put, the value of the position goes up or down 1-to-1 with the underlying stock price.
- Short call option – assuming the position is held to expiration, if the stock price is less than the strike price, the position keeps premium. Otherwise, the position loses value.
The premium earned from selling the call helps the combined portfolio beat a simple stock fund, even though the combined exposure (blue line) still falls as stock prices fall. However, once the short call is “in the money,” exercise payouts of the option are offset (covered) by gains on the stock. The upside is capped by the short call strike.
A protective put on the other hand works like insurance against the stock portfolio falling (below the strike price). The combined portfolio still provides exposure to upside, but the cost of the option (premium) reduces the return compared to a simple stock position (the blue line falls below the long stock line).
Chart 5: Long equity + single option
Overall, there are about 70 types of U.S. funds implementing covered call-like strategies with nearly $90 billion in total assets under management (AUM).
A deeper dive into buffer strategies
Buffer strategies tend to be slightly more complex with multiple layers of options. Buffer strategies aim to provide downside protection and some upside capture.
There are typically four major components of a traditional buffer strategy, and Chart 6 below illustrates each of the steps sequentially (note that the dark blue line represents the net payoff profile for each stage):
1. Establish Equity Exposure – either by going long the index or buying a deep in-the-money call option.
2. Set the “Cap” – by selling an out-of-the-money call option. This establishes the “cap,” or the limit to how much upside return the strategy can achieve.
Set the buffer range by:
3. Long Put Option – establishes the start of the buffer.
4. Short Put Option – establishes the end of the buffer and also partially funds the downside buffer.
Chart 6: How to create a buffer
Overall, Step 4 in Chart 6 highlights the expected payoff when combining all components. Though, we should note that the realized payoff may deviate from the expected payoff shown above depending on other factors, such as when an investor buys or sells the strategy relative to the start and end of the defined outcome period.
The major trade-off is the upside potential vs. downside protection. The buffer strategy can only earn a return up to the cap, so if the reference asset exceeds the cap, the buffer strategy will underperform.
Despite the potential underperformance in “up” markets, investors may still be drawn to buffer strategies due to their ability to limit downside at a lower cost than simply “buying a put,” thanks to selling of other options in the combination to earn back some premium.
Note that, generally, buffer strategies have historically outperformed underlying benchmarks during periods of market stress. For example, Chart 7 below highlights the rolling drawdown of a collection of buffer strategies from 2020 to the present, relative to the Nasdaq-100® (NDX®) and S&P 500. It shows that the grey area falls less than a simple stock portfolio (dots).
Chart 7: Rolling drawdown of buffer funds
Who is managing these ETFs?
Interestingly, the majority of assets are managed by only a few ETF issuers (Chart 8):
- J.P. Morgan is the largest issuer, with around $65 billion in assets and the two largest ETFs (JEPQ and JEPI).
- They are followed by First Trust and Innovator ETFs, both of which focus much more on downside protected (orange) strategies.
- Although Global X, Amplify and Neos have fewer ETFs, their suites include some of the most popular ETFs with options (QYLD, XYLD, DIVO and SPYI).
Chart 8: Top ETF issuers of option overlays
Why this matters
Option strategies can be tailored to meet different types of defined outcomes. ETFs with options make it easy for investors to access some of these more complicated strategies.
However, because these types of strategies are complex, they may not be for everyone. As always, it’s important for investors to understand what they are buying to avoid any undesired outcomes.
Overall, option overlay strategies represent just another example of how evolved the U.S. markets have become.