We’ve spoken previously about how Exchange-Traded Funds (ETFs) represent efficient tools that allow you to quickly access different types of assets and investment exposures. We also discussed the increasing popularity of options in recent years.
Today, we’ll combine both topics to look at ETFs that contain options. It turns out to be a growth segment of the ETF landscape.
ETFs with options offer different returns to their stock portfolio
Options are slightly different from stocks. Options expire – sometimes money, sometimes not, but returns are not “linear.” Additionally, the options are:
- It is held individually (one foot).
- Combined with other options (multi-league).
- It is combined with the underlying stock exposure (overlay).
You can use this to create a portfolio with a variety of rewards, including additional income and downside protection.
More ETFs with options
As the data below shows, assets to options overlay ETFs have increased significantly since 2020, when the market experienced a sharp divestment around the Covid-19 pandemic.
Prior to 2020, the assets managed (AUM) in this category were approximately $5 billion. Today, these same kinds of strategies represent over $160 billion, with the majority of assets investing in either income strengthening or hedging strategies (more on the differences later).
Chart 1: Option Overlay ETF Assets
In fact, looking at the launches of annual ETFs, we see that options overlay funds generally represent 20% to 30% of new stock ETF launches since 2019 (Chart 2).
Chart 2: Starting an option overlay ETF
What is the most popular option overlay?
Not all option overlay strategies are the same. Options can be combined in a portfolio to target predefined results. In Chart 3, funds are grouped according to NASDAQ’s Internal Fund Classification Method.
- Strengthened Income Strategy (Green) Mainly trying to increase your income. This is usually done by writing or selling options that will receive premium income in addition to long stock exposures (e.g., a cover call like QYLD or put wight like WTPI).
- Hedging Strategy (Orange) It aims to protect the shortcomings while offering upward participation mainly through long put options and short call options (traditional buffer funds such as PDEC and FNOV, or 100% downside protection funds such as TJUL).
- Performance enhancement (blue) Try to surpass your benchmarks through increased revenue (e.g., OVL, or SPYC).
As of March 2025, we have optionally tallied over 430 equity ETFs, representing over $160 billion in AUM. However, as shown below, income and hedging strategies represent almost all of the total assets in the space.
Chart 3: Option Overlay ETF with Strategic Focus
How do they work?
Each overlay strategy is usually a combination of long and short positions of call and placement options, all of which produce slightly different results. The diagram below shows how the combination of stock exposure (diagonal) and optional exposure (“hockey stick”) combines the denoted portfolio return profiles of “not linear” (blue lines are not straight).
Chart 4: Hypothetical payoffs for different kinds of option overlays
The above diagram shows how some of the popular overlay strategies work. Note that there are usually trade-offs to create these returns. The blue line is sometimes above the diagonal stock return (better) and sometimes below (and worse).
Each has different advantages:
- Cover Call – Generate income with limited profits.
- Protective put – Complete protection for shortcomings, but join upside.
- Traditional Buffer Fund – Use buffer downside (up to a specific point) to generate upward equity participation.
- 100% downside protection (or collar) – Like traditional buffer funds, the drawbacks are fully protected.
Dive deep into covered calls and protective puts
First option overlay ETF in the US market It is an Investco S&P 500 Buy/Write ETF (PBP) and has implemented the S&P 500 cover call strategy.
Typically, there are two positions in a cover call.
- Long Stock Exposure – Simply put, the value of the position rises one-to-one with the underlying stock price.
- Short Call Options – Assuming that the position is kept to an expiration date, if the stock price is lower than the strike price, the position will be premium. Otherwise, the position loses value.
The premiums you get from the sale of Cole help the total portfolio beat simple equity funds, despite the combination of exposure (blue line) still falling as the stock price falls. However, when a short call goes “in the money,” optional exercise payouts are offset (covered) by inventory profits. The advantage is concluded with a short call strike.
Protected puts, meanwhile, act like insurance on a stock portfolio (below strike prices). The combined portfolio still provides exposure to the upside, but the cost of the option (premium) reduces returns compared to a simple inventory location (the blue line is below the long stock line).
Chart 5: Long Equity + Single Options
Overall, it implements a Call-like strategy, which covers around 70 different US funds, with a total assets under management (AUM) of around $90 billion.
Dive deep into the buffer strategy
Buffer strategies tend to be slightly complicated across multiple options layers. The buffer strategy is intended to provide downside protection and some upside capture.
Typically, traditional buffer strategies have four main components, with chart 6 below showing each step in order (note that the dark blue lines represent the net payoff profile for each stage):
1. Establishing stock exposure – By going longer through the index or purchasing deep money call options.
2. Set the “cap” – Out of the money call options are sold. This establishes a “cap,” or limit on the amount of uplift the strategy can achieve.
Set the buffer range as follows:
3. Long put options – Establishes the start of the buffer.
4. Short put options – Establish the end of the buffer and partially fund the downward buffer.
Chart 6: How to create a buffer
Overall, Step 4 of Chart 6 highlights the expected payoffs when combining all the components. However, it should be noted that payoffs realized from the above predicted payoffs may deviate depending on other factors, such as when investors buy or sell strategies relative to the start and end of a defined outcome period.
The main trade-offs are upward potential and downside protection. Buffer strategies can only get returns up to the cap, so if the reference asset exceeds the cap, the buffer strategy will perform poorly.
Despite potential inability to perform in the “UP” market, investors may be drawn to buffer strategies because they have the ability to limit the downside at a lower cost than simply “buying a Put.”
It should be noted that buffer strategies have generally surpassed the underlying benchmarks historically during periods of market stress. For example, Chart 7 below highlights the involving collection of buffer strategies from 2020 to the present, compared to the NASDAQ-100® (NDX®) and the S&P 500. The gray area indicates lower than a simple inventory portfolio (DOT).
Chart 7: Buffer Fund Rolling Drawdown
Who manages these ETFs?
Interestingly, the majority of assets are managed by only a small number of ETF issuers (chart 8):
- JP Morgan is the largest publisher, with approximately $65 billion in assets and two largest ETFs (JEPQ and JEPI).
- Then comes First Trust and Innovator ETF.
- Although there are fewer ETFs from Global X, Amplify and Neos, the suite includes the most popular ETFs with options (QYLD, XYLD, Divo, SPYI).
Chart 8: Top ETF Publisher for Option Overlays
Why is this important?
Optional strategies can be tailored to meet different types of defined results. With options, ETFs give investors easy access to some of these more complex strategies.
However, these types of strategies are complex and may not be the case for everyone. As always, it is important for investors to understand what They buy to avoid unwanted consequences.
Overall, the option overlay strategy represents another example of how the US market has evolved.
