Leveraged ETF Option Barbells

Abstract

This article compares how Standard & Poor’s (S&P) 500 and Nasdaq-100 barbell strategies invested primarily in fixed income assets and in-the-money call options on the underlying index (or their 2x and 3x leveraged counterparts) achieve a significant percentage of upside appreciation while reducing downside risk. From 2010 to 2022, a barbell strategy composed of 88% 7 to 10-year Treasury bonds and 12% 0.7 delta 6-month call options on the underlying index achieves more than 81% of the geometric annual return of the index while reducing major losses by 21% to 52%, as exemplified by the market declines in the last quarter of 2018 and the 2020 COVID-19 crash. Using call options on the 2x or 3x LETF performs marginally worse than simply using options on the index and only gives a 32% to 47% participation rate of the underlying LETF returns. However, the outlined 88/12 barbell strategy is exposed to interest rate risk, and in the 10 months ending June 30, 2022, the 88/12 barbells lost −16% or more as the options lost more than 90% of their value while treasuries declined −10.4%.