Business

Best Offense Is Defense? This Sophisticated Market Play Helps Investors Protect Themselves From Dramatic Lows

Flamingoimages | Istock | Getty Images

It's a class of exchange-traded funds designed to prevent your portfolio from hitting dramatic lows — but it may require a level of sophistication.

The idea: Incorporate short-term levered plays including covered call and risk-reversal strategies in order to help investors customize their own defensive strategies similar to hedging.

However, it may come with an unintended price. According to Ben Slavin of BNY Mellon, issuers and advisors may struggle to keep up with continuous product growth and change. 

"The toolkit has expanded immensely over the last couple years, and it's going to continue to grow," the company's global head of ETFs told CNBC's "ETF Edge" last week. "That said, the negative is really trying to parse all of these different products. Really understand what you're owning and explain that to investors or even advisors who are struggling to keep up with the nuances between these products."

Liquidity providers and asset servicers may experience difficulties with product expansion as well, he added.

Yet, it may still benefit investors with low-risk appetites.

Andrew McOrmond, managing director at WallachBeth Capital, joined Slavin on "ETF Edge" to explain how investors can hold defensive, risk-averse positions using leveraged products. 

Playing the levered game

Covered calls grant protection to clients looking to minimize losses, McOrmond said. These short-term levered plays better define outcomes, but in turn investors may miss out on gains.

"If you sell options, and the market moves against you, you'll be protected — but you're going to just reduce your upside [potential]," he explained, noting covered calls are "the only option" for risk-averse clients because hedging is complicated for the individual.

McOrmond sees the latest market rallies as a potentially good opportunity to "hedge." In July, the Nasdaq jumped 12%, and the S&P 500 is up more than 8%.

Buffering the blow

The First Trust Cboe Vest Fund of Buffer ETFs, under the ticker BUFR, was designed to supply capital appreciation and limit downside risk for investors, according to the financial consulting company

"The name is perfect," McOrmond said of the Cboe Vest Fund. "You're buffered on both sides."

The defensive strategy uses ladders to preserve capital, and option collars "buffer" the investment to mitigate losses investors might face.

Slavin also suggests the fund of buffer ETFs, citing interest and activity in the space.

The First Trust Cboe Vest Fund of Buffer ETFs is up more than 5% this month.

Disclosure: : Neither Andrew McOrmond nor Ben Slavin have ownership of First Trust Cboe Vest Fund of Buffer ETFs products.

Disclaimer

Copyright CNBCs - CNBC
Contact Us