As U.S. stock markets rise, many increasingly cautious domestic investors have turned to options and derivatives for protection against changing sentiment.
There has been an explosion in funds in the US that are using options in one form or another to act as a hedge, whether it is through so-called covered call writing, or more structured defined outcomes. Options are very popular on US retail platforms like Robinhood, but derivatives are also finding their way into more mainstream products, such as exchange-traded funds.
These products are finally becoming available in the UK via ETFs. Arguably the most popular strategy is covering call writing, which involves owning a portfolio of, say, US stocks linked to a benchmark index and then selling options that limit those stocks' gains in price – giving up, for example, any price return. Monthly above a certain level. 2 percent increase.
US company Global JPMorgan has also weighed in on this space in the UK with an active ETF called the JPM Global Equity Premium Income UCITS ETF (ticker JEPG), which aims to deliver consistent income of 7 to 9 percent annually while also owning stocks that closely track Global stock indices.
The idea behind all these covered call strategies – UK giant Schroders has been offering this through its Maxizer portfolio for decades – is to provide enhanced income, which in turn could mean reduced downside volatility. The snag is that these options funds will always underperform a simple buy-and-hold strategy in the underlying index, as long as it continues to rise.
Options and derivatives also find their way into another strategy involving ETFs, in both the US and the UK, which can generally be called defined outcomes investing. There are dozens of these funds in the US but at the moment only one in the UK, again from Global X, called the S&P 500 Annual Buffer UCITS ETF (ticker SPAB). Its strategy is to protect against the first 15 percent of losses on the S&P 500 by buying a so-called spread (option), while also capping upside exposure.
According to Global .in the past five years (from an admittedly low base), while nearly doubling in 2023 alone.
This strategy does not seem to have attracted much money in the UK yet but its time may come if the US market momentum stalls.
Another explanation for this lukewarm uptake is that the UK already has a range of solutions called regulated products. These, in my view, had a bad reputation when they were sold before the 2008 global financial crisis via major banks and building societies. But the sector has improved its behavior in recent years and has begun to achieve very good and stable returns, through the ups and downs of the market.
The most popular product is the so-called automatic call or put plan, which uses a benchmark index, usually the FTSE 100 (of one form or another) and then promises to pay a fixed return – usually between 5 and 10 per cent per annum. year, if after one year this indicator is at or above the opening level. There are other variations on this theme, and it's important to say that because these products may seem a bit complicated at first glance, the vast majority of them are sold via independent financial advisors. A growing number of advisors are using these structures as a hybrid strategy between bonds and stocks.
Importantly, returns have been strong since the global financial crisis. Ian Lowes, a consultant based in the North East, runs StructuredProductReview.com, which has been tracking the growing range of products with defined outcomes. According to its latest report, more than 96 percent of the 629 plans that matured during 2023 gave positive returns to investors. The average annual return was 6.51 percent over 3.14 years.
This sums up nicely how these products sit within a range of returns – you would have made a lot more investing directly in stocks but with a structured product you would have gotten a fixed return that was less volatile and was higher than that on offer from most (but not all) bonds.
It is also important to say that there is counterparty risk since the options bundled within the products involve large investment banks. Most of these structured products involve potential risks to your capital, usually kicking in if the benchmark falls, for example, by 30 to 50 percent during the plan period (usually between three to 10 years).
An alternative that does not involve any risks to your capital is called a structured deposit. But these usually provide something closer to the returns of cash savings but over a longer term than most savings bonds.
Popular products in the market include Meteor's FTSE 100 Step Down Index. This works out over seven years and offers an annual return of 7.5 per cent as long as the index (FTSE 100) is either at or above its launch level, although it is the level of the index that results in lower returns over several years, making it easier to get compensation.
Another favorite is Mariana's 10:10 plan for March 2024 (option 2), which includes Morgan Stanley as a counterparty. It offers a maximum potential return over 10 years of 9.75 per cent per annum as long as the reference index (a version of the FTSE 100 index called the FTSE CSDI) does not move down – your capital is at risk if that index falls by more than 30 per cent. Starting level.
Another interesting structured product comes from provider Tempo and is called the Long Income Plan. This provides a high level of quarterly income for at least three years. One option pays 6.1 percent annual interest as long as its reference index (another type of FTSE 100 index) does not fall by more than 35 percent from its starting level, while another option pays 7.2 percent annually provided that the index does not fall . t decrease by more than 15 percent.
A final note is that these options are widely used by many professional investors – wander around under the hood of a widely popular fund like Ruffer Investment Company, with its explicit mandate of wealth preservation, and you'll find plenty of options. In fact, one fund manager, Atlantic House, has built a loyal following with its Defined Return Fund, which invests only in a series of structured products sold to institutions.
I've owned this fund for years, and I appreciate its consistent return of about 7 percent per year, all achieved with low volatility and using options and structured products.
David Stevenson is an active private investor. He has written for the UK Structured Products Association and Tempo. Email: adventurous@ft.com. Tenth: @advinvestor.
