Matt Levine made a wonderful comment in his "Money Stuff" column. Obviously, this is a joke and not the way real buffered ETFs work, but I thought it was a brilliant clarification anyway.
Here is a simple, bad financial product:
You give me $100.
In a year, I give you back the return on the S&P 500 stock index, but (1) if the index is down, you don’t lose any money and just get your $100 back, and (2) if the index is up more than 5%, you only get the first 5% of returns. If the S&P goes up 3%, you get $103 back. If it goes up 5%, you get $105. If it goes up 37%, you get $105. If it goes down 5%, you get $100. If it goes down 37%, you get $100.
You have bought 100% downside protection by giving away the upside above 105%.
How do I manufacture this product? That is, how do I make sure that I have enough money in every scenario to pay you back? Well, I could probably do some stuff with options. But the simplest and most obvious approach is:
I use your $100 to buy a one-year Treasury bill, which pays roughly 5.1% interest.
In a year I have $105.10.
At that point, I look at the return on the S&P. If it’s 5% or more, I give you $105 and keep the remaining $0.10. If it’s zero or negative, I give you $100 and keep the remaining $5.10. In between, I give you $100 plus the S&P’s return and keep the rest.
This is, like I said, a very bad product. You should not buy it; you should just buy the Treasury bill yourself instead.
Statistics: Posted by nisiprius — Tue Jul 02, 2024 9:00 am — Replies 17 — Views 1982