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U.S. exchange-traded fund (ETF) issuers may have hit “peak 2024” with plans to launch 25 ETFs that combine leveraged exposure and covered call options selling, the hottest trend right now.
New York-based GraniteShares has filed to launch a series of single-stock-based “Yield Boost” ETFs that would sell put options on leveraged ETFs (also largely single-stock) issued by competing providers.
ETFs may benefit from significant premium income from option issuance, but will combine capped capital returns with uncapped downside risk from the underlying leverage exposure.
“We were shocked by this filing,” said Brian Armour, North American passive strategies research director, likening it to a “spaghetti cannon.”
“Product development has taken the path of throwing as much spaghetti as possible at the wall and seeing what sticks,” Armour added.
“Wow, that’s a 2024 peak,” added Elizabeth Kashner, director of global funds analysis at FactSet.
GraniteShares’ proposed ETFs would invest in a wide range of single assets, from individual stocks such as the Magnificent Seven to Bitcoin, gold, volatility and select stock indexes and sectors.
It then sells 1.5x to 3x leveraged put options on ETFs issued by providers such as Direxion and ProShares. The collateral is primarily invested in bonds.
The maximum profit is the premium income from selling the option plus a limited upside upside up to the option’s strike price, assuming the price of the underlying ETF rises to this level.
However, investors will be fully exposed to losses in the underlying ETF, which, due to their leveraged nature, can easily be huge, but those losses will only be mitigated by the premium income that will be banked no matter what happens.
The proposed YieldBoost ETF thus capitalizes on two of the hottest trends in the US ETF market.
Options-selling covered call ETFs have grown rapidly in recent years, exemplified by JPMorgan’s wildly popular Equity Premium Income ETF (JEPI), whose assets have soared to $33.6 billion, making it the most popular active ETF in the world.
Assets in U.S. exchange-traded ETFs that Morningstar Direct classifies as “derivative income,” which includes most covered call investment vehicles, reached a record $70.7 billion at the end of April, up from just $3 billion at the end of 2020.
Leveraged and inverse ETFs have also been attracting attention, though their growth has not been as rapid, with total assets growing from $54.4 billion at the end of 2020 to $94.9 billion in April, according to Morningstar.
“Covered call ETFs have been one of the most popular trends over the past year, while single-stock leveraged ETFs have been among the better-performing products during that same time,” said Todd Rosenbluth, head of research at consultancy BettaFi Inc. “So it’s not surprising that asset managers would want to combine the two into one product.”
In particular, Rosenbluth pointed to the success of NVDL, a GraniteShares ETF that offers 2x daily exposure to chipmaker Nvidia, which has returned 474% since its inception in December 2022 and currently holds $2.6 billion.
“GraniteShares has capitalized on investors’ gambling mentality and has had great success with its leveraged single-stock ETFs. Most of these have struggled, but the success of its 2x leveraged Nvidia ETF has given the company solid gains,” Armour said.
“This success has funded the recent onslaught of yield-boosting ETFs.”
“We have a customer base that is desperate for income,” said GraniteShares Chief Executive Officer Will Lind.
“First and foremost, it’s an income product. It’s an extension of other income strategies that we’ve seen in the market over the past few years, from broad indexes to individual stocks.”
“It’s a very popular category because it offers yields that you can’t get from traditional bonds or dividend stocks.”
Due to the inherent volatility of the underlying ETFs, these YieldBoosts may generate more options income than other covered call strategies, but due to their structure, they also increase the likelihood of significant declines in the price of the underlying assets.
“Theoretically, the more volatility you have, the more revenue you can generate,” Lind said. “There’s plenty of demand for this.”
But FactSet’s Kashner, a former options trader, wasn’t convinced by the investment rationale for the Yield Boost ETF.
“The underlying thing is geared exposure, and most investors who invest in geared exposure do so because they believe the underlying asset will rise and they want it to rise further,” she said.
“I don’t understand the reasoning behind the investment thesis that says, ‘Meta will get to the moon, but not very far.’ You’re only getting a portion of the profits and giving up the dividends.”
“What percentage of investors understand how these funds work and what the potential costs and benefits are?” Kushner asked, adding that with other covered call strategies such as JEPI, “the number of investors who put money in may not align with the number of investors who understand it.”
Armour was more blunt: “Investors in these ETFs may be surprised to learn that these high-risk strategies come with limited upside potential, little downside potential and inefficient tax base. Investors are best off staying away from these ETFs.”
If the Securities and Exchange Commission doesn’t object to the filing, the ETF could launch as soon as Aug. 7. Lind said he expects fees to be in line with similar covered call ETFs, at 70 to 100 basis points.
