They're BAAACK!

 Annuity hucksters are back with more style and less substance than ever.

Under the rubric of "Defined Outcome" you get anything but. Correction: some of your losses ARE defined by the huge unecessary fees you pay to put on such a ridiculous strategy. 

Index-linked annuity advertisements creep up like weeds whenever the stock market falls.

I believe these ads mislead and are harmful to your wealth. The above is a rough picture of the investment portion of a one year index-linked annuity contract. These expensive and opaque insurance contracts generally offer, for a 1 year or other term, a certain amount of "buffer" or "shield" from market declines along with a capped share of the gain if the market rises.

This "insurance" strategy can easily be created with exchange traded index options with total transparency, total liquidity, at extremely low cost with NO withdrawal fees and a far smaller cash deposit than any insurance purchase. 

The SPY, S&P 500 ETF, chart above shows the profits and loss from a "split strike with short put" options strategy.  It's something like the "split strike" strategy touted by Bernie Madoff but without the upside.  Whether Madoff is a tip off or not, this is the terrible strategy:

As of last night's (12/22/21) closing prices, with SPY at 470, (1000 shares = $470,000),
Buy 10 SPY 12/16/2022 (1-year) 470 (at-the-money) Puts for roughly $39.20 or $39,200
Sell 10 SPY 12/16/2022 (1-year) 420 (10% out-of-the-money) Puts for $23.875 or $23,875
Sell 10 SPY 12/16/2022 (1-year) 520 (10% in-the-money) Puts for $65.155 or $65,155

These trades combined will CREDIT your options account with +$49,830.
Total commissions at my broker for these trades are $20.85. 

The initial margin required for the 10 lot position according to my broker today is $116,510.

This is fully covered by your 1000 share long position which is the "reason" you are putting this hedging strategy on in the first place. 

With options you have full transparency with market prices available anytime the market is open.

You have total control! You can get out ANYTIME for the same $20.85 commissions.

There are NO withdrawal fees, no waiting periods, no hassle at all to get in or get out!

This $49+K credit is the "protection" against the loss of your real portfolio, which in this example, is the $470,000 invested in the SPY.  This example is slightly more than 10% but you can change your credit by adjusting the strike prices of your options.

Why is this strategy so bad? Look at the chart: your losses can be UNLIMITED and your gains are capped, the exact opposite what any investor wants. If you really do want protection, forget selling puts and just buy the at-the-money put. The "married put" is a pricey insurance policy that costs 11% of your portfolio and gives you total protection from the downside with 100% upside (except for the insurance premium) if the SPY rises.

The chart above is so bad that option traders don't even sell this strategy. You would be hard pressed to find the above options payoff chart online.  Its so bad that only annuity salesmen would sell it.

Feel free to post comments.

Disclaimer: Posts are for education only and not investment advice, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors.