TikTok, YouTube, and Reddit are currently trending mainstream among novice investors – ETFs with derivatives, promoted by die-hard financiers on these online platforms. Capitalizing on the human weakness for easy money, experienced traders in their educational videos advertise potential payouts, the returns of which can allegedly exceed 100%.
Known in the industry as exchange-traded funds, they’ve become a hit with retail investors, making a slew of bold trades, including ones that add to the daily returns of the planet’s most popular stocks. For reference: exchange-traded funds with derivatives are investment funds that use derivative financial instruments to achieve their investment goals. Derivatives are contracts whose value depends on the underlying asset – shares, bonds, commodities or currency.
This year, investors have poured about $50 billion into ETF strategies for big tech companies like Nvidia Corp. and Tesla Inc.
ETF issuers are constantly launching new products to meet investor demand. This is fueling the growth of new and existing companies as competition for funding and commissions intensifies in an industry now valued at $10 trillion. ETFs give investors access to assets – stocks, bonds and other securities, which makes them attractive.
Dynamics of the derivatives market in the USA
The growth of the derivatives market in the US is truly impressive. A record 164 new derivatives launches have been registered this year, and companies have applied for 25 more at the same time. Over the past five years, assets in this industry have grown sixfold, reaching $300 billion.
The main interest in these funds is caused by strategies of selling options, which allow you to receive cash, which is then returned to shareholders in the form of dividends. Although these funds are often touted for their defensive features, it is the high returns, sometimes as high as 100% or more, that attract the attention of loyal investors.
This growth shows that there is a significant interest in investment strategies based on derivatives and how they can be used to achieve high returns.
Todd Akin, a 38-year-old investor, runs a popular YouTube channel called Unconventional Wealth Ideas. He teaches his followers how to earn ETF dividends in a diversified portfolio. His motto is “I let dividends replace my 9 to 5,” which means he lives on investment income, not an office salary.
Exchange-traded funds often track the market or specific stocks. For example, the YieldMax Coin Option Income Strategy ETF has paid out more than 100% of its current share value in cash to owners over the past year. However, due to the ETF’s falling price, its total return through 2024 has fallen, and it is lagging behind the company it tracks, Coinbase Global Inc.
This shows that even with high payouts, investors should be careful and understand the risks associated with investing in ETFs.
The success story of JPMorgan Equity Premium Income in a bear market
A bear market is a period when asset prices – stocks – fall 20% or more from their recent highs and remain at that level for a long time. The 2022 bear market was driven by economic uncertainty, inflation, rising interest rates, and geopolitical tensions. This led to a significant drop in market quotations, which became a serious test for many investors.
It was all the more surprising that during the bear market of 2022, the JPMorgan Equity Premium Income fund showed impressive results. Through a strategy of selling options, the fund was able to cushion the decline of the S&P 500 index by almost 20%, making it an attractive haven for investors looking for stable income. The fund’s return was about 8%, and its assets more than tripled to $17 billion. This caused a veritable “gold rush” among providers, who started offering a variety of derivatives-based funds with different return targets and leverage levels.
This success of JEPI highlights the importance of understanding the risks and opportunities associated with investing in funds that use derivatives.
The main problem is that high income payouts – 30% or more – can put pressure on the fund’s net asset value. This means that while investors may earn high returns, the value of their investments may decline. This strategy may be attractive to investors looking for high income, but it is important to understand the risks associated with such investments.
Experienced traders advise investors to be cautious when they see high monthly payouts and to understand how covered call funds work. They also recommend diversifying your investments to reduce risk.
The frenzy surrounding leveraged ETFs
Nothing is stopping the frenzy around leveraged ETFs, especially those related to Nvidia. Assets of such funds grew to $5 billion from $200 million at the beginning of the year. Traders who were able to overcome volatility experienced monthly gains of 59% and losses of 15%. This growth has caught the attention of other managers who are also looking to take advantage of this trend.
A trader at NEOS Investments notes that focusing only on how ETFs perform relative to the indexes they track is a mistake. It is also important to consider the payouts that investors receive. He emphasizes that buyers should consider total return when choosing investments.
The expert emphasizes the importance of understanding the risks associated with each investment, regardless of its profitability. He emphasizes that investors should delve into the details and be cautious, especially when it comes to high-yield investments.
While in theory relying on investor caution is the right approach, in practice the loud promises of retail traders can drown out the voices of market professionals. This creates a risk that investors may not be fully aware of all the possible consequences of their investment decisions.
A financier from JPMorgan notes that ETFs are a modern way of investing that allows you to use both active and passive strategies. However, he also cautions that not all ETF investments are the best, and it’s important to understand how they work.
Meme stock euphoria
The meme-stock euphoria that swept the US market three years ago is gaining momentum again. Meme shares of GameStop and AMC are once again attracting the attention of retail investors, who are actively trading them.
This time, however, the situation is slightly different. While meme stocks remain popular, they have proven to be less profitable compared to stocks of major companies such as Tesla, Apple and Coinbase. For example, only 44% of AMC deals were profitable, compared to 51% for GameStop.
Roundhill Investments has seen significant interest in its products, particularly the Roundhill Innovation-100 0DTE Covered Call Strategy ETF (QDTE). Launched in March 2024, this fund has already raised over $450 million.
QDTE uses a covered call strategy with zero expiration (0DTE) that allows you to generate income every week by selling options on the Innovation-100 index. This strategy appeals to many retail investors looking for steady income, although it also has its risks.
Roundhill also launched a small-cap covered call fund in response to demand from retail investors. The company’s popularity has grown so much that they are getting requests for merchandising – t-shirts, hats and water bottles – with their ETF logos.
Investors who are interested in these products are not just following memes, but are serious about making a profit. Stock market experts stress the importance of learning and understanding how ETFs work to avoid potential risks.
There are various objections to ETF investing strategies, especially when it comes to high monthly payouts. While such payouts may be real, they are often accompanied by a reduction in the ETF’s net asset value. This is similar to the ex-dividend effect in common stocks, where the stock price declines after the dividend is paid.
Case in point: The founder of Sandstone Capital LLC, who retired from law enforcement three years ago, is a cautious investor. He gets consistent monthly dividend income, but his experience with the YieldMax TSLA Option Income ETF (TSLY) has not been so successful. A small investment in this fund resulted in a 40% loss, which forced him to sell it shortly after buying it.
What is a “graded buffer” and “protected call” for an investor
Interestingly, many retail investors do not use risk management tools such as stop-loss orders, which can lead to significant losses. At the same time, investors who use these tools and focus on stocks of large companies achieve higher returns.
On Wall Street, sophisticated financial instruments are used to manage risk and generate profits. The so-called step-up buffer – Step-Up Buffer – provides a certain level of protection against losses, but only up to a certain limit. For example, an investor may be protected against the first 10% of losses, but any losses beyond that level will be fully borne by the investor. This allows investors to profit when the market rises, but with limited risk when the market falls.
Protected Call – a strategy that combines ownership of shares with the sale of call options on these shares. This allows the investor to receive a premium from selling the options, which can offset some of the losses if the stock price declines. However, if the share price increases significantly, the investor may lose the opportunity to fully profit from this increase.
“Stepped buffer” and “protected call” are important concepts for some types of ETFs. While these tools can provide a certain level of protection, they can also be very complex and require a deep understanding of the market and financial strategies. Even experienced investors can encounter difficulties in their use, which can lead to unpredictable consequences.
Tatyana Morarash
