Just minutes after I was gloating about my £500,000 retirement package two weeks ago, my mum called to tell me that my dad had been hit by a motorbike and was in hospital.
my pride. his downfall. I haven't read the Old Testament, but I'm pretty sure Proverbs 16:18 says otherwise. A car ran a red light and crashed, causing a ruptured intestine.
I don't need it at 82 years old. By the time I arrived in Sydney, there was no scotch on the plane and my father had left the theater. I told the surgeon that something terrible was going to happen. Let's hope so, he answered.
Just a month after his boat exploded and two years after he lost his job over a lame joke, this latest drama highlights the ups and downs of life. I'm sure all of our readers have their own stories of rapidly changing fortunes.
Please send me an email. Read it to your new patient, but avoid anything funny because he might tear the stapler. Market ups and downs are a good topic. Humorless, yet charming.
Especially this week's wild rise and fall in stocks. Still, what bothers me is how fewer investors think a drop this much is worth worrying about compared to the past few years. For example, the cost of three months of protection against a small decline in the S&P 500 and the cost of a potential upside remains about half of its average since 2021, although it has risen slightly.
In other words, stockholders aren't worried about scratches on their handlebars to exploit their father's accident as a metaphor. The extraordinary rise in stock prices around the world in the first quarter pushed bullish sentiment indicators to extreme levels.
But at the same time, the fear of annihilation also attacks. Consider the Chicago Options Exchange Volatility Index, which measures expectations of the future volatility of U.S. stocks. The cost of a call option (the right to buy a future index at today's price) was recently the most expensive in the past five years compared to a put option (the right to sell).
In other words, the market is betting that future volatility will be higher, not lower. Perhaps it will be either a rise in stock prices due to lower interest rates, or a spike in productivity due to artificial intelligence. Or it will crash if inflation picks up (in the US?) or geopolitics worsens.
Any of these scenarios is possible. As usual, no one wants to miss out while others run off with their hair patted. But it's also natural to be afraid of hitting the sidewalk or eating with a straw.
This problem is theoretically easy to solve. Just sell everything right before the crash and buy again before it recovers. Back in the real world, professional investors use derivatives to protect their backside while maintaining exposure to the open road.
However, financial institutions have access to the world's derivatives exchanges and an army of smart bankers willing to sell innovative structured products. All at a relatively low cost considering its size.
What about us retailers? In fact, there are exchange-traded funds designed with exactly his two concerns listed above in mind. These are commonly known as “buffered” or “determined” ETFs.
Buffered funds hold a customized basket of options in a way that limits losses (to, say, 15 percent) over a specified period of time (e.g., one year). The problem is that there is a cap on the profit (up to, say, 10%).
You can choose downside protection. On the other hand, the upside price is determined by market conditions. Interest rates are important. And when volatility is low, these funds generally have lower upside limits because they earn premium short options that they use to buy protection, and vice versa.
Option prices are sensitive. Therefore, when a new fund is launched, the upper limit can vary significantly. At the beginning of 2022, the popular Innovator U.S. Equity Power Buffer ETF had a cap of 9%. One year later, it had more than doubled.
Of course, two years ago, US stock investors would have appreciated being protected against losses of up to 15%. The S&P 500 ended five spots lower. Buyers of the fund in January 2023 would have enjoyed 20%, but the market rose another 5%.
Similarly, buffered funds also underperformed last quarter. And because the stock currently has low volatility, the upper limit on upside on offer these days isn't great. Also keep in mind that if you invest at the start, you only bag the advertised protection and cap.
According to Morningstar data, such tricks don't come cheap. For example, the median fee for the 230 funds available in the U.S. is 80 basis points. Another issue is that returns do not include dividends.
Despite these shortcomings, its assets have more than tripled in the past two years, even though most of its activities take place in the United States. My UK online broker suggested some S&P 500 funds and he one FTSE 100 fund.
But I think I'll pass. This is my logic. Most developed stock markets are not accident-prone enough to warrant protection, and they rise frequently enough to reach a ceiling. Even the crappy FTSE 100 is up more than 14% every three times over the last 30 times. There were only seven times when the stock fell by more than a tenth, and only nine times when the stock fell by more than 5%.
Additionally, I invest a quarter of my portfolio in bonds in case stock prices plummet. And the stocks I own are cheap, so the correction should ease. My energy ETFs also come in handy when stock prices drop due to inflation.
But the good news is that there are many investors who are desperate for protection. they may need it. For them, buffered ETFs are worth a look. I see my father nodding his head in pain on the other side of the ward.
The author is a former portfolio manager. Email: stuart.kirk@ft.com; twitter: @stuartkirk__
