One of the best attributes of active ETFs happens to be risk management. By taking an active approach, investors don’t have to get stuck seeing losses as a passive index takes the skids. Managers can take necessary steps to reduce volatility and drawdowns. Increasingly, that task is being handled by derivatives. So-called buffer ETFs are some of the fastest-growing active ETFs around. With that in mind, using active ETFs benefits risk management and applying it to a very volatile sector makes a ton of sense.
And you can’t get much more volatile than Bitcoin.
But now investors have some downside protection against Bitcoin’s volatility and potential declines. A series of new ETFs of various issuers have come to the table offering downside protection through options and derivatives. These active ETFs could be the best way to play the digital currency and get more investors into the asset class.
A Growing, Yet Volatile Asset Class
The growth of Bitcoin and other digital assets has been breathtaking over the last five years. What started as a niche idea has quickly gone mainstream. The basics behind cryptocurrencies are pretty easy to understand. The best way to think of them is as ‘digital dollars’ stored in the cloud or accessed through a digital key.
Those digital dollars have now received support from the Trump Administration, Wall Street, institutional investors, and countless other pundits. In fact Bitcoin has grown into the seventh largest asset class, with a $1.9 trillion market cap.
With this growing legitimacy, Bitcoin has now been thought of as a must-have security for portfolios that can provide a host of wins. This includes diversification benefits, with Bitcoin featuring low correlations to stocks (S&P 500), bonds (U.S, Aggregate), and real estate (REITs) of 0.42%, 0.23%, and 0.38%, respectively.
Additionally, the asset class features far greater historical and potential returns than stocks, bonds, and other alternatives. The digital currency is now even being seen as a way to boost retirement income and reduce longevity risk when added to traditional 60/40 portfolios.
The only problem?
Bitcoin is extremely volatile and features big drawdowns. For example, Bitcoin’s five biggest drawdown periods saw the asset class sink anywhere from 31% to 83%. This chart from BlackRock highlights the one-year volatility of Bitcoin versus stocks, bonds, and even gold. As you can see, Bitcoin is far bouncier than even gold. 1
Source: Blackrock
Tempering That Volatility
So, Bitcoin has plenty of growth potential and portfolio benefits to offer investors. Reducing the volatility of the asset class is key to extracting those benefits without feeling much of the downside risk and drawdowns.
And luckily, a new variety of active ETFs could help.
As Bitcoin has grown in size and importance, options and other derivatives have come to market covering both the digital currency itself as well as exchange traded products like the iShares Bitcoin Trust ETF (IBIT). We forget, but options were created as risk management tools.
This is the realm that Buffer ETFs play in. These actively managed ETFs use derivatives contracts to gain the desired outcome. Managers will buy options contracts to track the performance of their underlying indexes and, simultaneously, sell the call options tied to the same index. This creates a price floor for the fund that kicks in when the market has a drawdown below this amount. At the same time, the options contracts create a cap on gains. The basic idea is that investors can limit or remove losses and have a planned outcome for gains.
There are a few ways to structure them, but the basic idea is the same. Investors can limit their downside losses—potentially even 100%—while giving up some of the potential upside.
Now, investors looking to add Bitcoin to their portfolios can take advantage of buffer ETFs and options-focused funds in the sector. Both Innovator and Calamos have launched new buffer ETFs offering price floors and downside protection, while Simplify has added options overlay ETFs to provide income and reduce losses on Bitcoin. First Trust and Roundhill also have new Bitcoin buffer ETFs in the works.
The idea behind these ETFs is that investors can own Bitcoin, and gain from its potential high growth while reducing their losses on the asset class as it goes through its paces.
For example, the Calamos Bitcoin 90 Series Structured Alt Protection ETF – January (CBXJ) will protect investors in losses below 10%. So, no matter how far Bitcoin falls this year, investors can only lose a maximum of 10% of their money. The upside for the ETF is capped at 29.15%. That means investors can still gain nearly 30% on Bitcoin this year. The Innovator Uncapped Bitcoin 20 Floor ETF (QBF) provides a protection of 20% in losses for a quarter and doesn’t cap the upside.
A Huge Win for Bitcoin Adoption
Ultimately, buffer ETFs have proven themselves on the equity side of the equation. Both advisors and retail investors have started to use them in spades to hedge portions of their equity portfolios much in the same way that they use annuities, albeit at a much lower cost than annuities and without the surrender issues.
The caveat is that the upside caps of some of these products can limit overall returns and potential on the equity side.
For Bitcoin, the upside caps may not matter as much. As a more fringe asset class, not really used to pull the weight of a portfolio, capping gains has less of an effect than limiting the downside losses. After all, the magic weighting for Bitcoin in a portfolio seems to be 5% to 6% to hit the sweet spot of benefits before the issues with digital currencies add too much risk to a portfolio.
With the buffer products, investors and their advisors could feel more comfortable owning Bitcoin in their portfolios knowing that they can’t lose more than a certain amount of money. That could spur the adoption of the asset class and continue to make Bitcoin more mainstream.
One thing to remember is that many buffered ETFs are tied to a certain month and provide protection up to that month. Buying and holding a defined outcome ETF off schedule will lose some of the defined benefits while selling will provide less of the upside potential. These are more of a buy-and-hold/rebalance when the time comes kind of product.
Buffered Bitcoin ETFs
These ETFs were selected based on their exposure to Bitcoin using a buffered strategy. They have expenses between 0.61% and 6.15%.
| Ticker | Name | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|
| QBF | Innovator Uncapped Bitcoin 20 Floor ETF - Quarterly | 0.79% | ETF | Yes |
| MAXI | Simplify Bitcoin Strategy PLUS Income ETF | 6.1% | ETF | Yes |
| CBOJ | Calamos Bitcoin Structured Alt Protection ETF - January | 0.69% | ETF | Yes |
| CBXJ | Calamos Bitcoin 90 Series Structured Alt Protection ETF - January | 0.69% | ETF | Yes |
| CBTJ | Calamos Bitcoin 80 Series Structured Alt Protection ETF - January | 0.69% | ETF | Yes |
In the end, Bitcoin has a lot of promise for portfolios. And now investors have a way to tap that promise without some of the volatility and downside effects of the asset class. New buffered ETFs that use derivatives offer a chance for investors to use risk controls and active management to limit their downside while participating in the upside of the asset class.
Over time, these active ETFs could fill a vital role in portfolios just like buffered ETFs do on the equity side of the equation.
The Bottom Line
Bitcoin has quickly gone mainstream and is now considered a portfolio staple for many investors and advisors. However, it remains as volatile as ever. New actively managed buffered ETFs use options to cull some of the downside risk away from Bitcoin and allow the asset to shine on its own in a portfolio.
1 BlackRock (July 2024). Bitcoin volatility guide: Trends & insights for investors
