NUSI: ETF that uses a collar option strategy to protect against downside

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thebeerfund
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NUSI: ETF that uses a collar option strategy to protect against downside

Post by thebeerfund »

I'm currently planning to enter the market and I'm concerned about volatility, since I would like access to the funds on a 7-10 year horizon.
I came across an interesting ETF that uses an option collar strategy to protect against downside risk. That is, it sells call options against the underlying securities and then uses the proceeds to buy protective puts.

It's called NUSI, or Nationwide Risk-Managed Income ETF.

It's appealing to me for a few reasons:
  • I looked at its performance during the recent crash and it outperformed everything else.
  • It pays out a generous dividend (from the sale of call options) that is competitive with bond funds: 7.71% (which will certainly fluctuate if the market rebounds aggressively)
  • Although it has a higher expense ratio, it would be easier to buy this than try to build my own downside protection (e.g., buying protective puts), which can be a full time job.

My goals would be to avoid inflation risk and have reasonable returns without a large drawdown.

I had two questions:
  • What might be the risks with buying this ETF?
  • What would the tax treatment be when the stocks they trade have protective puts on them? I believe it resets the clock on capital gains. Are those taxes deducted by the fund manager from the returns or does it get paid by the holder when the 1099 is distributed?
For reference: NUSI Fact Sheet

Image
DesertMan
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by DesertMan »

Also interested. Here is the ETF.com profile. It says no K1 tax forms.
jjj_22
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by jjj_22 »

thebeerfund wrote: Tue May 05, 2020 5:39 pm
  • What might be the risks with buying this ETF?
I think the main and fundamental risk is of underperforming during good times: selling calls means the upside is capped, and puts may expire worthless.

Also, most of the times are good times.

The expense ratio means you're paying for the privilege of underperforming most of the time.

But if you're willing to pay that cost for decreased drawdowns, maybe that's a legit tradeoff. I don't understand options well enough to have a sense for how this would behave under all kinds of different possible scenarios for the next 7-10 years though.

I admit, also, that I am inherently skeptical of strategies like this, so I am approaching it with a negative rather than neutral outlook.
annu
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by annu »

Ok, I had some times so compares this with BND, total bond market. See below. Why would I not just increase bnd allocation, with lower expenses and also simpler invesment, get same or better results? Bonds are there to minimize drawdowns, something that this etf will do, with all kind of maneuvers.



https://www.portfoliovisualizer.com/bac ... ion2_2=100
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thebeerfund
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by thebeerfund »

annu wrote: Wed May 06, 2020 12:47 am Ok, I had some times so compares this with BND, total bond market. See below. Why would I not just increase bnd allocation, with lower expenses and also simpler invesment, get same or better results? Bonds are there to minimize drawdowns, something that this etf will do, with all kind of maneuvers.



https://www.portfoliovisualizer.com/bac ... ion2_2=100
Thanks for pulling this together. However. I still can't get it to return more + have lower drawdowns. I tried adding QQQ as 50% of the portfolio (to reflect the exposure in NUSI) but that doesn't seem to make it work either. See here.

Also, the dividend yield is much larger from selling calls on NUSI's underlying positions vs. the coupon payments from bonds, since interest rates are effectively zero right now.
annu
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by annu »

thebeerfund wrote: Wed May 06, 2020 1:08 am
annu wrote: Wed May 06, 2020 12:47 am Ok, I had some times so compares this with BND, total bond market. See below. Why would I not just increase bnd allocation, with lower expenses and also simpler invesment, get same or better results? Bonds are there to minimize drawdowns, something that this etf will do, with all kind of maneuvers.



https://www.portfoliovisualizer.com/bac ... ion2_2=100
Thanks for pulling this together. However. I still can't get it to return more + have lower drawdowns. I tried adding QQQ as 50% of the portfolio (to reflect the exposure in NUSI) but that doesn't seem to make it work either. See here.

Also, the dividend yield is much larger from selling calls on NUSI's underlying positions vs. the coupon payments from bonds, since interest rates are effectively zero right now.
Well, if you are focusing on least drawdown, I will not pair with qqq, buy maybe long term treasury. See below, it beats it in both returns and lower drawdown.

https://www.portfoliovisualizer.com/bac ... tion3_2=40
RomeoMustDie
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by RomeoMustDie »

thebeerfund wrote: Tue May 05, 2020 5:39 pm I'm currently planning to enter the market and I'm concerned about volatility, since I would like access to the funds on a 7-10 year horizon.
I came across an interesting ETF that uses an option collar strategy to protect against downside risk. That is, it sells call options against the underlying securities and then uses the proceeds to buy protective puts.

It's called NUSI, or Nationwide Risk-Managed Income ETF.

It's appealing to me for a few reasons:
  • I looked at its performance during the recent crash and it outperformed everything else.
  • It pays out a generous dividend (from the sale of call options) that is competitive with bond funds: 7.71% (which will certainly fluctuate if the market rebounds aggressively)
  • Although it has a higher expense ratio, it would be easier to buy this than try to build my own downside protection (e.g., buying protective puts), which can be a full time job.

My goals would be to avoid inflation risk and have reasonable returns without a large drawdown.

I had two questions:
  • What might be the risks with buying this ETF?
  • What would the tax treatment be when the stocks they trade have protective puts on them? I believe it resets the clock on capital gains. Are those taxes deducted by the fund manager from the returns or does it get paid by the holder when the 1099 is distributed?
For reference: NUSI Fact Sheet

Image
Seems like you can get this same effect by shifting more AA to BND.
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Nate79
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by Nate79 »

Interesting how it looks like they have taken their methodology of something like the fixed indexed annuities and turned it into an ETF, probably for a lower cost. I wonder if their insurance sales team will be pushing this or not?
David Althaus
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by David Althaus »

I certainly admit to negative bias against these things as they tend to blow up at the worst possible time. Maybe what you're actually saying "My risk level is too high because I seek a hedge." Consider lowering your overall risk level to a place where you no longer need such a hedge strategy. Lowering risk in this manner is more predictable and certainly a lot less expensive.

All the best
DesertMan
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by DesertMan »

The arguments for using something like this over just adding bonds to your portfolio are...
1. Interest rates are extremely low so bonds don't give you much return.
2. For the same reason, you will lose principal on your bonds if rates rise and they almost certainly will
3. You have simplicity here in onw ETF vs having to buy a target fund that suits you (but see the ishares allocations ETFs)
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by grabiner »

There is no free lunch in the market. Before expenses, any risk reduction should come with a commensurate reduction in expected returns. After expenses, it may be worse; you could get risk reduction for the same price by holding less stock and buying a bond fund. In a taxable account, it may also be less tax-efficient, as there will be capital gains on the options, or on stocks if the options are exercised.
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mojorisin
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by mojorisin »

OP: what did you end up doing here? I have been investigating NUSI vs. BND as well. Or I'm considering shifting to 50% BND 50% NUSI in my IRA's (where I hold my bonds).
effigy98
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by effigy98 »

I replaced bonds with NUSI. The monthly dividend is uplifting to see them streaming in (at 8%) and the downside protection is nearly as good as short term treasuries. This is my favorite etf now. I may get a 2.5% M1 finance loan and put it all in NUSI.
mojorisin
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by mojorisin »

effigy98 wrote: Tue Mar 16, 2021 12:45 am I replaced bonds with NUSI. The monthly dividend is uplifting to see them streaming in (at 8%) and the downside protection is nearly as good as short term treasuries. This is my favorite etf now. I may get a 2.5% M1 finance loan and put it all in NUSI.
You timed it good. Bond funds are now down ~8% off their highs with increased rates.

I'll be moving some of my bond funds to NUSI. Keep us posted if your view changes.
bberris
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by bberris »

Alternative: save the 0.7 % expense and buy the corresponding ETF for the NASDAQ 100 and index options (buy a put, sell a call)
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by bberris »

annu wrote: Wed May 06, 2020 2:37 am
thebeerfund wrote: Wed May 06, 2020 1:08 am
annu wrote: Wed May 06, 2020 12:47 am Ok, I had some times so compares this with BND, total bond market. See below. Why would I not just increase bnd allocation, with lower expenses and also simpler invesment, get same or better results? Bonds are there to minimize drawdowns, something that this etf will do, with all kind of maneuvers.



https://www.portfoliovisualizer.com/bac ... ion2_2=100
Thanks for pulling this together. However. I still can't get it to return more + have lower drawdowns. I tried adding QQQ as 50% of the portfolio (to reflect the exposure in NUSI) but that doesn't seem to make it work either. See here.

Also, the dividend yield is much larger from selling calls on NUSI's underlying positions vs. the coupon payments from bonds, since interest rates are effectively zero right now.
Well, if you are focusing on least drawdown, I will not pair with qqq, buy maybe long term treasury. See below, it beats it in both returns and lower drawdown.

https://www.portfoliovisualizer.com/bac ... tion3_2=40
You are getting high returns because the risk is higher than bonds. If you bought a stock, and its put, and wrote its call both at the strike price of the current stock price you would have completely hedged the stock position; the put protecting the downside and the call obligating you for the upside. In an efficient market, you would have slightly higher return than the risk free rate (because of the counterparty risk). If you want higher returns, increase your risk; buy a slightly out-of-the-money put, sell a OOM call.
mojorisin
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by mojorisin »

Can somebody explain how the risk in NUSI is higher than bonds?
I understand how bonds and bond funds work.
I understand what NUSI is doing to provide a return.

However I have not connected the dots of why NUSI is higher risk than Bonds.

In addition, what is the downside risk of NUSI? It held well during the Covid crash. So what are the mechanics of it's downside? What would drop the price or cause a loss of investment?
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Scott S
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by Scott S »

So, instead of moving our bond money into boring dividend stocks, we're moving it into funds employing derivatives on large-cap tech companies?

This should end well. :D
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effigy98
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by effigy98 »

Still very happy with NUSI. It is doing exactly what I needed it to do for my asset allocation and risk tolerance. In a world of negative real rates, we are being forced to be creative. The monthly dividend is psychologically helpful for me as well. I tried doing my own NUSI and I just don't have the discipline to do it right consistently. I will gladly pay a reasonable fee for that service. I miss my long bonds, but wouldn't have missed the crazy drawdowns. The only bonds I still have indirectly with NTSX. NTSX I still like the best as my core holding and NUSI just plays another part of my asset allocation. I have backtested max drawdowns down to under 5% while easily maintaining the 4% inflation adjusted SWR which is my goal.
mojorisin
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by mojorisin »

I moved 3% of my allocation to a mix of NUSI and QYLD. Lowered bond allocation from 15% to 12%. Its increased compounding interest rate. $200k of NUSI is generating more than $600k of my bond allocation in compounding dividends.
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by Escapevelocity »

I need to see how this performs in an extended bear market for tech before I’m willing to invest.
danielfp
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by danielfp »

The danger in NUSI, that is almost never discussed, is related to the option premium values when market conditions change. This strategy works as intended in up trending market conditions (expensive calls to sell, cheap puts to buy) but faces an ugly realization when the market goes down for an extended period of time and suddenly your puts are very expensive to buy and your calls are not worth much. It is great for quick downside protection - like the COVID crash - not so much for an extended bear market.

NUSI buys 5% OTM puts and sells 5% OTM calls with one month expirations. If the market goes down for more than a month, the puts become incredibly expensive to buy and the calls pay basically nothing. The fund would then start to erode NAV to pay the dividend distributions or would aggressively cut them.

An ETF like NUSI is also a tax trap. The dividends paid are mostly return of capital (ROC) which means the taxes are deferred and your cost basis is lowered. This means that you only pay taxes once you sell your shares, and you pay the difference between current price and your adjusted cost basis. This incentivizes you to never sell the ETF, because if you have been holding for 10 years and your cost adjusted basis drops to 0, you would basically pay huge taxes on selling that. If the dividend drops to 1% because options premia deteriorate against the strategy and you don't want to hold it, tough luck.

This is not a replacement for bonds, you are getting paid a very high yield compared to short term treasuries because you are taking a very high risk compared to short term bonds, whether you understand it or not. Sorry, markets don't give any free lunch.

This is why I call it NOOSEE.
hi_there
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by hi_there »

Hi, OP. From my experience, collared index strategies have very similar performance to some kind of stock/bond allocation - suspiciously similar in fact. I would encourage you to plot the returns of this ETF and compare them to a 50/50 or 60/40 portfolio of stocks and bonds. The results might surprise you!

I don't know much about how taxes might compare between the two approaches.

Also, if you are looking for risk optimization, why not diversify away from NDX stock allocation?
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by grabiner »

danielfp wrote: Wed Jul 21, 2021 2:03 pm An ETF like NUSI is also a tax trap. The dividends paid are mostly return of capital (ROC) which means the taxes are deferred and your cost basis is lowered. This means that you only pay taxes once you sell your shares, and you pay the difference between current price and your adjusted cost basis. This incentivizes you to never sell the ETF, because if you have been holding for 10 years and your cost adjusted basis drops to 0, you would basically pay huge taxes on selling that. If the dividend drops to 1% because options premia deteriorate against the strategy and you don't want to hold it, tough luck.
And if the cost basis drops to zero, future return-of-capital distributions become taxable as capital gains.

Note that this isn't specific to NUSI. In particular, many closed-end funds (and some other ETFs and open-end funds) pay a steady distribution, but part of that distribution is a return of capital. This allows you to get an income stream from the fund, but it erodes the principal if you do not reinvest the distributions. A bond fund which does this will hold fewer bonds as time goes on.
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illumination
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by illumination »

danielfp wrote: Wed Jul 21, 2021 2:03 pm

An ETF like NUSI is also a tax trap. The dividends paid are mostly return of capital (ROC) which means the taxes are deferred and your cost basis is lowered. This means that you only pay taxes once you sell your shares, and you pay the difference between current price and your adjusted cost basis. This incentivizes you to never sell the ETF, because if you have been holding for 10 years and your cost adjusted basis drops to 0, you would basically pay huge taxes on selling that. If the dividend drops to 1% because options premia deteriorate against the strategy and you don't want to hold it, tough luck.
Setting aside the risk factor of a fund like this, couldn't you make the case it's actually more tax efficient than bonds or other fixed income instruments in that much of what it throws off can be characterized as a return of capital instead of taxable income? Allowing you to defer taxes to down the road, just like a pre-tax retirement account, until you cash out?

You're not paying more taxes in total than if say you had a CD that paid out these same distributions, you just get the luxury of deferring much of it for down the road.

Does the brokerage keep track all of this adjusted cost basis data over the years? It almost seems like getting a K-1 from an MLP.
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by danielfp »

illumination wrote: Wed Jul 21, 2021 5:24 pm Setting aside the risk factor of a fund like this, couldn't you make the case it's actually more tax efficient than bonds or other fixed income instruments in that much of what it throws off can be characterized as a return of capital instead of taxable income? Allowing you to defer taxes to down the road, just like a pre-tax retirement account, until you cash out?

You're not paying more taxes in total than if say you had a CD that paid out these same distributions, you just get the luxury of deferring much of it for down the road.

Does the brokerage keep track all of this adjusted cost basis data over the years? It almost seems like getting a K-1 from an MLP.
Depends on the bond fund. You have bond-containing funds that will keep the yield payments inside the fund to grow capital, like NTSX does. A bond fund that doesn't do frequent yield distributions will be more tax efficient than a fund like this, as you will be able to compound gains before having to pay taxes. Levered government bond funds, like TMF or TYD, will also keep yields largely inside the fund.

However, my point is not so much about tax efficiency, but about the psychological position this puts you in. The value of your position in a fund like NUSI isn't growing substantially through time, so unlike liquidating a QQQ or NTSX position after 10 years and paying taxes, here you are liquidating a position and paying taxes on money you've already spent, so it feels like you are getting hit with an unforeseen cost.

It is very tempting to never pay those taxes by never selling your shares, regardless of how bad the dividend or capital erosion gets, while if your taxes over qualified dividends are paid or you are paying taxes to get gains, it doesn't feel the same.

Imagine if you only had to pay taxes on your job if you quit, how likely would you be to quit after 10 years? It is tempting to never quit, regardless of how crappy your job is, to never have to pay those taxes :?
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by illumination »

danielfp wrote: Wed Jul 21, 2021 6:51 pm
illumination wrote: Wed Jul 21, 2021 5:24 pm Setting aside the risk factor of a fund like this, couldn't you make the case it's actually more tax efficient than bonds or other fixed income instruments in that much of what it throws off can be characterized as a return of capital instead of taxable income? Allowing you to defer taxes to down the road, just like a pre-tax retirement account, until you cash out?

You're not paying more taxes in total than if say you had a CD that paid out these same distributions, you just get the luxury of deferring much of it for down the road.

Does the brokerage keep track all of this adjusted cost basis data over the years? It almost seems like getting a K-1 from an MLP.
Depends on the bond fund. You have bond-containing funds that will keep the yield payments inside the fund to grow capital, like NTSX does. A bond fund that doesn't do frequent yield distributions will be more tax efficient than a fund like this, as you will be able to compound gains before having to pay taxes. Levered government bond funds, like TMF or TYD, will also keep yields largely inside the fund.

However, my point is not so much about tax efficiency, but about the psychological position this puts you in. The value of your position in a fund like NUSI isn't growing substantially through time, so unlike liquidating a QQQ or NTSX position after 10 years and paying taxes, here you are liquidating a position and paying taxes on money you've already spent, so it feels like you are getting hit with an unforeseen cost.

It is very tempting to never pay those taxes by never selling your shares, regardless of how bad the dividend or capital erosion gets, while if your taxes over qualified dividends are paid or you are paying taxes to get gains, it doesn't feel the same.

Imagine if you only had to pay taxes on your job if you quit, how likely would you be to quit after 10 years? It is tempting to never quit, regardless of how crappy your job is, to never have to pay those taxes :?

I don't think NTSX is a very good example of a "bond fund" since it has heavy equity exposure. It tries to mimic the returns of a 60% stock 40% bond portfolio. I was making the comparison to something like BND (and what 99% of the time people are referring to when they are talking about a bond fund, CD, etc) in terms of distributions being taxed as income.

But I also don't think NUSI is a bond proxy in terms of safety, there's no argument there. But I would prefer to have distributions taxed the way NUSI does as a return of capital, all other things being equal. But just like a pre-tax retirement fund, there's going to be a bill due.

If I could have a "real" bond fund kick out distributions and it be considered a return of capital and defer the taxes, I would take that model over a traditional bond fund. Seems more tax efficient to defer when you are in a lower bracket later in life and you could even have some interesting estate planning options if you kept until death. Reminds me of an MLP.
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Re: NUSI: ETF that uses a collar option strategy to protect against downside

Post by danielfp »

illumination wrote: Wed Jul 21, 2021 10:02 pm If I could have a "real" bond fund kick out distributions and it be considered a return of capital and defer the taxes, I would take that model over a traditional bond fund. Seems more tax efficient to defer when you are in a lower bracket later in life and you could even have some interesting estate planning options if you kept until death. Reminds me of an MLP.
You could also buy a municipal bond ETF, which can be tax exempt. There are some ETFs that specialize on tax exemption, for example VTEB.
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