First Trust debuts Target Outcome ETF with leveraged upside

Jul 14th, 2021 | By | Category: Alternatives / Multi-Asset

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First Trust has initiated the rollout of a new series of Target Outcome ETFs that provide leveraged upside exposure to the S&P 500 with single exposure and a buffer to the downside.

First Trust debuts Target Outcome ETF with leveraged upside

Ryan Issakainen, Senior Vice President, ETF Strategist at First Trust.

The FT Cboe Vest US Equity Enhance & Moderate Buffer ETF – June (XJUN US) has listed on Cboe BZX Exchange and comes with an expense ratio of 0.85%.

Similar to First Trust’s existing Target Outcome ETFs, the fund is actively managed by Cboe Vest Financial and uses FLexible EXchange (FLEX) Options – customizable exchange-traded option contracts guaranteed for settlement by the Options Clearing Corporation – to tailor its risk/return profile over a specific outcome period.

Specifically, the ETF aims to deliver double the positive price return of the SPDR S&P 500 ETF (SPY US) while maintaining unleveraged exposure to the downside and providing a buffer against the first 15% of potential losses over a period of one year.

The fund’s accelerated gains and downside protection come at the cost of a cap on upside performance which is determined by the market conditions prevailing at the time the option contracts are purchased. The initial level of this cap is 6.16% for a one-year period ending on 17 June 2022.

At the end of the outcome period, the fund does not expire but, instead, rebalances and resets, providing investors with a new 15% buffer and a new upside cap which will be dependent on market conditions at that time. According to First Trust, this makes the ETF better suited as a longer-term core holding rather than as a tool for ultra-tactical trading like traditional leveraged products.

Investors should note, however, that as the target outcome profile has been tailored for the entire outcome period, the ETF’s interim returns may behave differently during the outcome period.

Due to the time value of the underlying options, the ETF’s return will not be directly proportional to the return on the reference SPDR S&P 500 ETF. As such, it may lag the leveraged performance of SPY when markets are trending upwards, especially in the earlier stages of the outcome period.

Investors who purchase the ETF after the outcome period has begun may also be exposed to magnified risk on the downside in so far as the ETF has risen since the beginning of its outcome period. Again, the degree to which downside risk is magnified would depend on the time value of the underlying options.

These dynamics of target outcome investing can present a challenge, particularly for more complex products such as those that incorporate leveraged exposure. First Trust does, however, provide full daily disclosure for each of its Target Outcome ETFs including remaining cap and buffer levels, remaining downside before buffer, and remaining days in the outcome period.

Ryan Issakainen, Senior Vice President, ETF Strategist at First Trust, said: “The popularity of Target Outcome ETFs has continued to grow among investment professionals seeking new ways to manage risk for their clients, while still providing opportunities for growth.”

Karan Sood, CEO of Cboe Vest, added: “For some investors, the ability to potentially enhance upside returns is as critical as their need to shield some downside losses. The Enhance & Moderate Buffer ETF Strategy is designed to strike the right balance of a downside buffer and enhanced capped upside in moderately volatile market regimes. We are pleased to work with First Trust to bring this strategy to market.”

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