More Options: Small-Cap ETF Uses Daily Puts to Boost Yield

Liam Gibson

Man invested in stock

Investors seeking enhanced income from their ETF portfolio have a new small-cap play to size up. 

Expanding its collection of income options funds, Defiance ETFs has launched the Defiance R2000 Enhanced Options Income ETF (NYSE Arca: IWMY). The new fund was listed on the New York Stock Exchange, Arca, on Monday, October 30, under the ticker “IWMY.”

Sylvia Jablonski, Defiance ETFs CEO, sees the actively managed fund offering as “a new paradigm for income generation” in its category.

“IWMY has the potential to reshape the Russell 2000 options income strategies within the ETF landscape,” she said.

The ETF will pay out any distributions every month. The fund holds a mix of Treasury bonds and daily put options targeting the Russell 2000 Index (which tracks small-cap companies). Defiance's strategy for boosting monthly comes down to the technicalities of put options. 

The fund will sell in-the-money puts every trading day to try and realize rapid time decay to deliver outsized yields. Put options are said to be “in the money” when the strike price exceeds the underlying security's market price. By exercising these options at the right point in time, the seller may potentially realize larger returns.

New Strategy

Defiance hasn't just targeted Russell with this play. The same strategy is available for the S&P 500 and the Nasdaq through The S&P 500 Enhanced Options Income ETF (“JEPY”) and The Nasdaq 100 Enhanced Options Income ETF (“QQQY“). JEPY has attracted over $50 million in assets under management (AUM) to date, while the QQQ has garnered over $130 million in AUM.

Options options-based ETFs are becoming increasingly popular and leading a trend toward innovative, alpha-seeking ETFs, VettaFi recently noted. 

“Advisors are increasingly comfortable with ETFs that incorporate options in a more efficient manner,” said Todd Rosenbluth, head of research at VettaFi.

No Hussle for Russell?

In 2023, the AI-fuelled rally of the “Magnificent Seven” (Apple, Microsoft, Meta, Amazon, Alphabet, Nvidia, and Tesla) made up virtually all growth in global equities. Their spurt has furthered American tech's dominance, with the seven representing almost 20 percent of all global equity value and US companies now accounting for 61 percent of global stocks, as opposed to less than 50 percent a decade ago. 

Unsurprisingly, The Russell 2000 Index didn't get an invite to the tech stocks party. The Russell 2000 Index is hovering around 1650 points, down over 5 percent year-to-date. Small-cap performance hasn't been so weak over a 100-week period since 2009.

However, there remains a case for netting more minnows. In July, the Financial Times highlighted small caps were reasonably priced on a price/book ratio when compared with the high multiples of the S&P 500. The publication posited that small-caps could do well if a soft landing scenario for the US economy were to eventuate, seeing as firms are usually more vulnerable to the business cycle. 

The Russell has retreated further since summer. Its price/book multiple is now in the bottom quintile of its range, going as far back as 1995. That could make small caps irresistible to bargain hunters who still expect a likely soft landing and see only upside for the little guys. 

Investors keen on the IWMY fund will want to consider the outlook for small caps over the short to medium term and whether Defiance's signature daily put options strategy could deliver the outsized monthly income it aims to deliver. 

IWMY comes with an expense ratio of 0.99 percent.

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