Simplifying put options in an ETF
In the case of a put options ETF like the one offered by Moat, through Longpoint ETFs, the portfolio is largely in a money market fund, generating interest. The management team is selling puts on stocks with liquid options markets that they believe should appreciate. The put contract means that the ETF will buy a stock that it’s sold a put on if it falls below a certain price. If that stock stays flat, rises, or even falls to a point above that set price, then the ETF will continue to hold cash and generate premiums and interest. If the price falls to the level of the put, then the ETF buys that stock.
While those purchases at low prices can seem positive in the age of v-shaped recoveries, Thom acknowledges that the risk is typically to the downside. He notes, though, that through premiums accrued the risk is typically lower than simply owning the stock, or owning the stock with a call option as that strategy would see the ETF participate in the full move to the downside. Once the stock is acquired, Thom says his team might go long on that equity if they believe in it. He says, though, that they are more likely to sell calls on the equity, which should eventually result in its sale, or sell the position outright.
Unlike a growing cohort of covered call ETFs, Thom says that put ETFs like his won’t use leverage to generate more options sales. Instead, the fund maintains a cash position large enough to buy all their put contracts if the market moves down significantly. In the meantime, the ETF is meant to deliver ‘base hits’ while offering better protection against the downside
Why puts now?
Two aspects of the contemporary market environment make puts more attractive in Thom’s view. The first is that interest rates have normalized and managers like him can now get solid interest income on the cash positions they need to maintain for a put strategy. The second, he says, is that US and Canadian equity markets are at all time highs. If a correction is coming, which has been a source of much debate through this year, then a put strategy can offer some protection against the downside and a chance to “get paid to wait.”
A put strategy, unlike a call option ETF, doesn’t rely on markets moving higher to generate its returns. Thom explains that if an investor or advisor believes the market can’t move higher from here, but still has income and total returns needs, then a strategy like that can help.