We’ve long written about the potential benefits behind so called, buffered ETFs. We first started investing in the ETFs on a selective basis at the beginning of 2020. Since then, there’s been acceptance surrounding these ETFs. Assets in buffered ETFs has grown, trading volumes have increased, and more firms have brought products to the market. All of these factors have combined to bring even more competition to the buffered ETF market which has driven new innovations. Before proceeding further, if you haven’t yet read our introduction to buffered ETFs, we’d recommend doing so.
More upside without more downside?
One area of innovation we’ve seen in the buffered ETF market are ETFs that provide double or triple an index return, while only participating in downside on a one-to-one basis. For example, if the S&P 500 or Nasdaq rises 5%, a corresponding type of this ETF would return 10% or 15%. If the related index fell 5%, the ETF would fall 5%. The appeal is obvious: these ETFs allow us to capture 2x-3x as much upside, without increasing any of our downside.
These types of ETFs are not marketed as “buffered” ETFs, since they don’t buffer against losses, but they are born out of the same family of funds. Furthermore, much like we’ve seen traditional buffered ETFs grow in popularity, we suspect that the same thing will happen here.
QTAP is a favorite buy right now
QTAP is an ETF that offers 3x the performance of the QQQ, a tech heavy index fund, that boasts an appealing return profile right now. QTAP’s outcome period began on April 1, 2021 and lasts until March 31, 2022. At the end of the outcome period, QTAP’s return will be 3x the return of QQQ up to a 21% cap, or 1:1 with QQQ to the downside.
To achieve the full 21% return, QTAP just needs QQQ to rise 7% (remember it is 3x QQQ’s return and 7% x 3% = 21%) over the course of its outcome period. If QQQ finished the outcome period higher by 15%, QTAP would still only return 21% (not 45%).
As of this writing, QTAP is already four months into its outcome period. For investors who haven’t yet bought into QTAP, this represents a possible advantage. You see, QQQ started the outcome period around $319 and has risen about 14.50% to above $365 since the outcome period began. This is double the return needed for QTAP to return its full 21%.
In order for QTAP to rise the full 21%, it needs QQQ to be above $341.50 on March 31, 2022, a level that is 6% below the current price. QTAP has risen 12% so far during the outcome period versus QQQ’s 14.50% gain (for an explainer on why the returns don’t match, read this). Thus, QQQ could fall 6.5% between now and the end of March 2022 and QTAP would still return about 8% from here (when accounting for expenses of the fund). In effect, QTAP, which didn’t start the outcome period with a buffer, now has a 6% buffer built into its price.
Probability vs performance
The graph below helps visualize how QQQ and QTAP have both performed, and highlight the remaining potential upside in QTAP from current prices:
QTAP is a favorite buy right now for clients who value higher probability returns versus higher performing returns. QTAP is capped at a 21% gain, but we can play from ahead knowing we can capture the remaining 8% gain even if QQQ falls 6% over the next 8 months. Where this trade-off doesn’t make sense, is for clients who want the highest return possible. If QQQ rallies more than 8% over the next 8 months, then QTAP will lag. But for those who don’t really care about what the market does, and like knowing they have a higher odds with of making 8% with lower risk than buying a tech ETF like QQQ outright, QTAP offers a great solution.
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