"Bonds are often viewed as a stabilizer, yet they can move in the same direction as stocks when interest rates rise. That happened in 2022, when both stocks and bonds fell together. Put options provide direct downside protection, but they come with a cost. The premium you pay creates a steady drag on returns, and options lose value over time through theta decay."
"There is, however, a fourth option that many retail investors overlook: buffer ETFs. These are more sophisticated ETFs that resemble the structured products often used by institutions. A useful way to think about them is like investing in a stock index with training wheels. The category has grown quickly, and there are now many variations of buffer ETFs on the market."
"Unlike a traditional ETF, PAPR does not actually hold stocks. Instead, it holds a portfolio of index options designed to produce a specific risk and return profile over a defined period. PAPR operates over a one year outcome period that begins every April. During that time, the ETF attempts to accomplish two things: protect investors against the first 15% of losses in the S&P 500 and track the price return of the S&P 500 up to a predetermined cap."
Retail investors traditionally hedge equity portfolios using bonds, put options, or cash, but each approach has drawbacks. Bonds can decline alongside stocks during rising interest rates, as occurred in 2022. Put options provide protection but charge premiums that drag returns through theta decay. Cash holdings struggle to outpace inflation over time. Buffer ETFs represent an alternative strategy that resembles structured products used by institutions. These sophisticated ETFs function like stock index investing with built-in protection. PAPR exemplifies this approach, operating on annual outcome periods and using index options to protect against the first 15% of S&P 500 losses while capping upside gains at predetermined levels.
Read at 24/7 Wall St.
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