ETF Wrap: BlackRock’s new fixed-income ETFs use an options strategy — here’s how they could pay off as investors focus on Fed rate hikes, says its U.S. head of bond ETFs

Hi! In this week’s ETF Wrap, I spoke with BlackRock’s U.S. head of bond ETFs about the firm’s new funds in fixed income that use an options strategy to provide an extra stream of cash flow – and what Fed Chair Powell’s highly-anticipated speech in Jackson Hole on Friday could mean for investors considering the first-of-its-kind, bond-market strategy.

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BlackRock this week launched a trio of bond-focused exchanged-traded funds that are designed to give investors an additional stream of cash flow tied to the options market.

The new ETFs — the iShares 20+ Year Treasury Bond BuyWrite Strategy ETF
TLTW,
+1.13%,
iShares High Yield Corporate Bond BuyWrite Strategy ETF
HYGW,
+0.39%
and iShares Investment Grade Corporate Bond BuyWrite Strategy ETF
LQDW,
+0.86%
— are the first of their kind in fixed income, according to Stephen Laipply, U.S. head of bond ETFs at BlackRock.

Each fund is set up to provide two income streams, one from the yields from the underlying ETF plus a premium collected from selling monthly call options on it.

BlackRock’s new offering comes as investors grapple with a surge in the cost of living in the U.S. that has prompted aggressive interest-rate hikes by the Federal Reserve, as well as questions surrounding how hawkish the Fed may be lifting its benchmark rate in September to curb high inflation. Investors will be listening for clues from Fed Chair Jerome Powell on Friday morning, when he is expected to give a speech at the Jackson Hole economic symposium.

Should the symposium in Jackson Hole, Wyo. result in “more hawkish statements” Friday, that may reinforce the view of some investors that interest rates don’t appear in “any danger of falling anytime soon,” giving them confidence to continue pursuing an income strategy, according to Laipply. They might take the view that they’d like to “sell the upside” on the belief the Fed will keep tightening its policy.

BlackRock’s new ETFs are “designed for investors who think that rates are sort of settling in here, or potentially going higher and would rather still hold fixed income,” said Laipply. “The basic investment thesis behind it is that in a rangebound, or even a rising rate environment, this allows you to generate additional income.”

Read: Kansas City Fed’s George kicks off Jackson Hole saying inflation remains broad-based and there is ‘more work to be done’

Also see: Fed’s Harker says he’d like to get benchmark rate above 3.4% and then ‘sit for a while’

U.S. bonds and stocks were clobbered in the first half of 2022 as investors anticipated that the Fed would be raising interest rates in an effort to bring soaring inflation under control. Treasury yields climbed, with the rate on the 10-year Treasury note
TMUBMUSD10Y,
3.032%
now around 3%, up from about 1.5% at the end of 2021.

The underlying ETFs for BlackRock’s buy-write investment strategy in fixed income are the iShares 20+ Year Treasury Bond ETF
TLT,
+1.39%
and iShares iBoxx $ High Yield Corporate Bond ETF
HYG,
+0.92%
and iShares iBoxx $ Investment Grade Corporate Bond ETF
LQD,
+1.04%.
All three funds had steep losses in the first six months of 2022 but have fared better since the end of June.

The iShares iBoxx $ High Yield Corporate Bond ETF has seen a 4.6% total return in the third quarter through Aug. 24, while the iShares iBoxx $ Investment Grade Corporate Bond ETF has gained 1.1%, according to FactSet data. The iShares 20+ Year Treasury Bond ETF is down on a total return basis over the same period, with a loss of 2.8%.

The options markets underlying these ETFs have matured to become “fairly liquid,” lending themselves well to BlackRock’s buy-write strategies, according to Laipply.

Each iShares BuyWrite ETF aims to track an index from Cboe Global Indices “by owning shares of the underlying ETF and selling one-month call options at a strike price at or near the closing price of the ETF the day before the strategy writes the call options,” BlackRock said in its Aug. 22 announcement on their launch. Each month, the new funds will distribute to shareholders the call option premiums collected as well as the underlying funds’ monthly distributions, the firm said.

A call option gives the holder the right but not the obligation to buy a security at an agreed upon price within a particular time frame. The buyer of the call option pays the seller a premium for that right.

BlackRock’s buy-write strategy in fixed income does best when rates are trading sideways “in a range,” because when they’re “rangebound” the premium is collected without finishing “in-the-money” or “out-of- the-money” with respect to the option contract, according to Laipply.

“If rates are actually falling, you would have done better simply by owning the underlying ETF, because with the buy-write strategy, by definition, you’re selling your upside, which is why you’re collecting a premium for that,” said Laipply. “So if you have a huge rally in the bond market,” he said, “you’re simply not going to participate in that.”

The good…

Best Performers

%Performance

Sprott Uranium Miners ETF
URNM,
+0.34%

13.0

Global X Uranium ETF
URA,
+0.49%

9.7

United States Oil Fund LP
USO,
-1.96%

5.2

VanEck Oil Services ETF
OIH,
+0.99%

5.1

First Trust Nasdaq and Oil & Gas ETF
FTXN,
+0.38%

5.0

Source: FactSet data through Wednesday, Aug. 24, excluding ETNs and leveraged products. Includes NYSE, Nasdaq and Cboe traded ETFs of $500 million or greater.

…and the bad

Worst Performers

%Performance

ARK Next Generation Internet ETF
ARKW,
+2.38%

-9.0

KraneShares Global Carbon Strategy ETF
KRBN,
-1.33%

-8.0

Amplify Transformational Data Sharing ETF
BLOK,
+0.96%

-7.6

ProShares Bitcoin Strategy ETF
BITO,
-0.75%

-7.2

ARK Fintech Innovation ETF
ARKF,
+2.77%

-6.8

Source: FactSet

New ETFs

Amplify ETFs announced Aug. 24 that it launched the Amplify Natural Resources Dividend Income ETF
NDIV,
+1.63%.
The index-based fund invests in “dividend-paying U.S. exchange-listed equities operating primarily in natural resource and commodity-related industries” such as energy, chemicals, agriculture, metals and mining, paper products and timber, Amplify said.

Invesco said Aug. 24 that it was offering the Invesco Agriculture Commodity Strategy No K-1 ETF
PDBA,
-0.64%
to actively invest in derivatives and “other financially-linked instruments” to gain exposure to eleven different grains, livestock and soft commodities “through a structure that does not produce a K-1 tax form.”