It has been a couple of years since Innovator ETFs pioneered defined outcome products, brought institutional level defensive strategies to the retail market, and arguably kicked off one of the most influential product development trends in the industry. We are currently about one month away from the funds that were launched in November 2021 hitting what I'll call their expiration. I'll first do a quick review of the strategies and then take a look at the performance of each of the funds and how it stacks up to the underlying asset.
Vertical Spreads 101
To review, these funds utilize what is at its essence a vertical spread trade. This is a multi-legged (multi-option contract) trade that can provide some unique payoff scenarios. Before we get into the update on the funds, let's do a quick review.
The basic elements of these vertical spread-based strategies are:
1. Establish a synthetic long position by buying an At The Money call which gains when the underlying rises, and selling an At The Money Put which loses when the underlying declines. The targeted underlying for these products is the SDPR S&P 500 ETF Trust (SPY) .
2. Establish the appropriate Bear Put Spread (buy a put at a given price, sell a put at a lower price) on the underlying. Initial Buffers include the basic Buffer (9%), Power Buffer (15%), and Ultra Buffer (30%).
3. The third part of this overall position involves selling a call which will help finance any cost of the spread and additionally help bring the overall cost of the combined positions in line with the underlying asset's current value. Selling this call also creates a cap on the fund's upside potential which is why you will see both Buffers and Caps displayed for these products.
Besides any capital risk, being a writer (seller) of listed options has an additional risk because any option seller who writes a contract that ends up in the money may end up being assigned, which means the Options Clearing Corp (OCC) can randomly select your contract as one that needs to be delivered against any investor holding that same strike as a long position.
In a multi-legged strategy being assigned can kill your trade in an instant. Innovator has managed to avoid the assignment problem by using a customizable option contract type called Flexible Exchange Options and known simply as FLEX options. FLEX options give them the flexibility to customize items like the strike price and expiration dates. As long as the issuer can find a market maker willing to provide continuous two-sided quotes during option trading hours then they are all set.
Buffer Funds in Action
As mentioned above each of these funds has a different buffer, and some buffers work differently than others. For example, the 9% buffer provided by the Innovator U.S. Equity Buffer ETF - December (BDEC) provides protection for the first 9% of losses in SPY over each annual period beginning the first trading day of December. The 15% buffer provided by the Innovator U.S. Equity Power Buffer ETF - December (PDEC) works the same way, protecting shareholders against the first 15% of drawdown in SPY over an annual period. The Innovator U.S. Equity Ultra Buffer ETF - December (UDEC) changes things up a little by protecting shareholders from SPY losses between -5% and -35%.
One other item to remember is from the third step outlined above. That call that is sold to round out the total position creates a cap on any potential gains from these portfolios. Had you purchased shares of BDEC on its first day of trading last December your upside would have been capped at 14.97%, PDEC would have capped you at 10.25%, and UDEC at 7.37%.
It's important to remember that full Caps and Buffers as stated are generally only obtainable on the first day of issuance because each day's market action will eat into either the cap or the buffer depending on that day's results. In fact, if you look at Innovator's product tables, you will see that they track not just the funds' returns but also the percentage of remaining Cap and Buffer currently available to potential shareholders as well as the total number of days remaining until the current period is over.
Now that I've laid out some background on these funds the table below shows the returns for all three plus SPY, which acts as the underlying asset for these strategies.
Source: Factset, All You Can ETF
My Take
With a little over 30 days left in the current annual period, you can see that the buffers aren't an exact science as you compare the fund's returns to SPY. Still, the funds do offer protections that seem to fall in line with the buffers as advertised.
One final note is that while each fund's strategy runs for a calendar year from the month they are launched, those strategies are renewed automatically at the end of each period. For example, current shareholders of BDEC will be rolled into the same strategy for the December 2022 to December 2023 period.
There are a lot of moving parts to these strategies and a lot of strategies as well but if you have an outlook for SPY or any of the other underlying exposures including technology (QQQ) , small-caps (IWM) , emerging markets (EEM) , or US Treasuries (TLT) then this fund suite is worth a closer look.
