‘Spaghetti cannon’ filings for 25 hot-trend ETFs prompt concerns

A US exchange traded fund issuer may have hit “peak 2024” with plans to launch 25 ETFs that would combine two of the hottest current trends: leveraged exposure and option-selling covered calls.

New York-based GraniteShares has filed to launch a family of “YieldBoost” ETFs, many of them based on single stocks, that would sell put options on leveraged ETFs — again many single-stock — issued by rival providers.

The ETFs would potentially benefit from significant option-writing premium income, but would combine a capped capital return with an uncapped downside risk from the underlying leveraged exposure.

“I was shocked by the filing,” said Bryan Armour, director of passive strategies research, North America at Morningstar, likening it to a “spaghetti cannon”.

“Product development has gone down the path of throwing as much spaghetti at the wall as possible, then seeing what sticks,” Armour added.

“Wow, this is peak 2024,” added Elisabeth Kashner, director of global fund analytics at FactSet.

GraniteShares’ proposed ETFs would invest in a range of single assets, from individual stocks, such as each of the Magnificent Seven, to bitcoin, gold, volatility and a selection of stocks indices and sectors.

They would then sell put options on ETFs leveraged between 1.5 and 3 times issued by providers such as Direxion and ProShares. The collateral would be primarily invested in fixed-income instruments.  

The maximum gain would be the premium income earned from selling the options, plus “a limited amount of upside appreciation” up to the option’s strike price — assuming the underlying ETF rises in price to this level.

However, investors would be fully exposed to any loss suffered by the underlying ETF — which could easily be chunky given its leveraged nature — only cushioned by the premium income, which is banked whatever happens.

As such, the proposed YieldBoost ETFs tap into two of the hottest trends in the US ETF market.

Option-selling covered call ETFs have boomed in recent years, as epitomised by JPMorgan’s wildly popular Equity Premium Income ETF (JEPI), which has surged to $33.6bn in assets, rendering it the world’s most popular active ETF.

US-listed ETFs classified as “derivative income” by Morningstar Direct, which includes most covered call vehicles, hit a record $70.7bn in assets at the end of April, up from just $3bn at the end of 2020.

Leveraged and inverse ETFs have also attracted more attention, even if their growth has not been as vertiginous, with total assets rising from $54.4bn at the end of 2020 to $94.9bn in April, according to Morningstar.  

“Covered call ETFs have been one of the most popular trends in the past year, while single stock leverage ETFs have been some of the better-performing products in the same period,” said Todd Rosenbluth, head of research at VettaFi, a consultancy, “so it’s not surprising that an asset manager wants to combine these in one product.”

In particular, Rosenbluth alluded to the success of NVDL, GraniteShares’ ETF offering 2x daily exposure to chipmaker Nvidia, which has returned 474 per cent since inception in December 2022 and currently holds $2.6bn.

“Preying on the gambling mentality of investors paid off in a big way for GraniteShares with its leveraged single stock ETFs — most of which have struggled but the success of its 2x leveraged Nvidia ETF has earned it a solid payday,” said Armour.

“That success footed the bill for the latest onslaught of YieldBoost ETFs.”

Will Rhind, chief executive of GraniteShares, said “we have a customer base that is crying out for income”.

“First and foremost this is an income product. It’s really an extension of some of the other income strategies that we have seen in the market over the past couple of years, from broad indices to single stocks.

“It’s a very popular category because it has been able to deliver a yield that is not available from either traditional fixed income or dividend-paying stocks.”

The inherently volatile nature of the underlying ETFs means these YieldBoost might be able to generate more option income than other covered call strategies, though their structure also increases the probability of a significant fall in the price of the underlying asset.

“Theoretically, the more volatility you have the more income you should be able to generate,” Rhind said. “There is plenty of demand for this.”

FactSet’s Kashner, a former options trader, though, was unconvinced by the investment rationale for the YieldBoost ETFs.

“The building block is geared exposure and most of the time investors who go into geared exposure are doing so because they believe the underlying is going up and they want more up,” she said.

“I can’t understand the investment rationale behind this: ‘I think Meta is going to the moon but not too far to the moon’? You are only getting some of the up and you are giving up the dividends.”

“What percentage of the investors will understand how these funds function and what the potential costs and benefits are?” Kashner asked, adding that with other covered call strategies such as JEPI “the number of investors who have put their money in it may not correspond to the number of investors who understand it”.

Armour was more forthright still. “Investors in these ETFs may be shocked that these high-risk strategies come with limited upside, most of the downside, and lots of tax-inefficient income. Investors are best steering clear of them,” he said.

If the US Securities and Exchange Commission does not object to the filings, the ETFs could launch on August 7. Rhind said he expected fees to be in line with those for similar covered call ETFs, at about 70-100 basis points.