History confirms one thing — drawdowns do occur, instilling a level of market uncertainty of varying degrees. Even when they’re not categorized as a “market crash,” sell-offs like the April tariff tantrum or 2022’s inflation-fueled slide in both stocks and bonds remind investors that their portfolios are vulnerable. Traditional safe haven assets like bonds and gold can provide cushions against market shocks. However, there are other avenues for downside protection that also can capture the upside. Take, for example, dual directional ETFs.
These ETF products were just one of the alternative investment strategies covered during the VettaFi Alternatives Symposium on July 31. TMX VettaFi investment strategist Cinthia Murphy joined Innovator’s director of product strategy Andrew Nelson. The two discussed how dual directional ETFs work and their place in an investor’s portfolio.
One of the highlights of dual directional ETFs is their ability to profit when the broad market via the S&P 500 falls. Inverse ETFs can accomplish the same, but they’re geared towards more savvy short-term traders. Heavy knowledge of tactical market strategies isn’t a qualifier for the dual directional ETFs investment strategy. For those who weren’t already aware of the existence of these products, Nelson opened the window into this world. And it’s a growing world at that.
“About $70 billion in the defined outcome/buffer space, about $10 billion in fresh assets just this year,” Nelson said of the size of the market.
“Where you see maybe value being added over time is giving investors choice, giving them tools that they can utilize (that) can give certainty into portfolios,” Nelson added. He underscored the importance of choice in the current market environment, though bonds still get the top allocation based on the symposium survey results.
Add More Certainty
As Nelson mentioned, the crux of Innovator’s dual directional strategy of dealing with market uncertainty is simple: Add more certainty. Defined outcome ETFs seek to achieve outcome parameters. In the case of dual directional ETFs, they provide a level of certainty for capturing gains on the upside, providing a buffer during drawdowns, and capturing upside during drawdowns via the use of options.
“We do dual directional as quite different than traditional buffer ETFs,” Nelson said. He noted that investors can “make money in negative markets and not just be flat, but actually be positive in negative markets, as opposed to providing just a buffer against downside losses.”
Innovator identifies four “layers” of dual directional ETFs, as seen in the infographic below. Layer 1 uses deep in-the-money call options for 1:1 exposure. The second layer uses put-spread options during a drawdown to attain a buffer. Layer 3 uses a bullish put-spread to transition the portfolio to a buffer during drawdowns. Then, layer 4 sells an upside call to neutralize the cost of the downside buffer. This mixture of selling and/or purchasing options contracts enables investors to capture upside and provides a downside buffer during market drawdowns. Essentially, it’s a win-win for investors, irrespective of what the markets (in this case the S&P 500) are doing.
Taste of Dual Directional in 2 Flavors
Innovator’s dual directional ETFs come in two flavors — the Innovator Equity Dual Directional 10 Buffer ETF (DDTL) and the Innovator Equity Dual Directional 15 Buffer ETF (DDFL). Investors don’t have to necessarily buy and sell during the defined outcome period (one year) to maximize each fund’s benefits. They can both be held indefinitely if investors so choose. Prospective investors intrigued by these funds should reference the “Investor Suitability” section of the prospectus for both funds (DDTL/DDFL).
The realized gains mentioned on the product websites for both will vary depending on the ETF. For DDTL, the cap is 12.59% when the S&P trends towards the upside. The fund can capture gains on the downside up to 10%. For DDFL, potential investors are capped at 8.79% for the upside, but when the S&P heads towards the downside, the fund can capture up to 15%.
The strategy may confound the casual investor. However, the ease of use is that it’s encapsulated in the convenience of an ETF wrapper. The active management style inherent to both funds means the investors can simply set it and forget it.
“The beauty of the ETF wrapper is that we’re handling all that for you — you just buy and hold the investment,” Nelson said.
DDTL and DDFL are just two of the full line of defined outcome ETFs from Innovator. With ETF products like DDTL and DDFL, Innovator pushes the creative envelope, offering investors myriad ways to attain alpha.
To watch the interview with Nelson in its entirety, view the symposium on demand here. Registration is free.
For more news, information, and analysis, visit VettaFi | ETF Trends.
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