For most people, volatility has a negative connotation. It signifies instability, risk, loss, and fear — all characteristics a financial investor tries to avoid. But not all volatility is bad or high-risk. In many ways, volatility is necessary for growth. We think the trick is distinguishing between good and bad volatility as well as choosing investment strategies that don’t merely avoid volatility, but aim to take advantage of it.
Volatility can be particularly beneficial to short-term investors who are looking closely at downturned prices with upward swing potential in the very near future. These investors attempt to buy at low prices to drive the prices back up, allowing the savvy investor to reap the returns. Following the downturns of a high-volatility market can lead to significant gains.
Low volatility, on the other hand, is potentially better for long-term investments, which could include investing for retirement. Because investments grow as a percentage of what’s invested, a large loss forces the money to work even harder to get back to where the baseline was prior to the downturn. Losses therefore potentially have a far greater impact on overall investments than gains.
Bad volatility may increase in a market upswing and likewise may crash during a downturn. Good volatility, however, may increase in a market upswing, but may possibly remain steady in a market downswing. Each type may have the same high, but managing how low the lows are could make all the difference for a healthy investment portfolio. If two people invested $1 million at the same time and had the same rate of return, their outcomes may be different depending on the magnitude of the downturn their portfolio is exposed to.
One of the more nuanced investment practice of limiting downturns is known as the Buffer Strategy. The Buffer Strategy uses options to provide a contractual limit to the investment payments in relation to a reference asset, like the S&P 500 Index. Options are financial derivatives that give buyers the right, but not the obligation, to buy or sell an underlying asset at an agreed-upon price and date. For example, a buffer ETF may utilize options to allow a percentage loss buffer, typically between 0% and -10%, while at the same time may provide upside exposure up to a stated return cap. While the Buffer Strategy does not take full advantage of market upswings, it is designed to mitigate against downswings that, as we’ve established, can possibly make a difference for a long-term investment portfolio.
The Buffer Strategy may provide an equity based risk mitigating alternative to diversifying a portfolio with bonds, which may not always offer the intended hedge in market downturns. Implementing a Buffer Strategy could be suitable for a portfolio as the risk-hedging portion with the potential added bonus of seeking modest returns in the upswings so investors can stay invested. This strategy may be especially relevant during times of high volatility that seem to be a new normal for the stock market.
Unlike other buffer ETFs, TrueShares offers a differentiated Structured Outcome ETF, such as APRZ, that has no upside cap, which may allow investors to participate in market upswings*. TrueShares Structured Outcome ETFs have an expected upside participation range that is communicated prior to the investment period, typically between 70-80%. The downside buffer aims to hedge against the first 8-12% of an investment’s loss. Though relatively new, like most buffer ETFs, TrueShares Structured Outcome ETFs reset annually.
