(Bloomberg) — This year’s hottest options trade has found its way into the $7.4 trillion ETF arena for the first time, in the latest push by the financial industry to tap booming demand for stock investments with an income stream.

Defiance ETFs is launching a fund on Thursday that sells ultra short-dated options on the Nasdaq 100 as part of its strategy. The product will be the first in the market to utilize so-called zero-day-to-expiration contracts, or 0DTE, as part of its design. 

The fund will write puts — bearish contracts that offer the buyer protection from index declines — to generate income. By offering options with such a short lifespan, the Defiance Nasdaq 100 Enhanced Options Income ETF (ticker QQQY) will be able to sell contracts more frequently, according to the issuer. That will help the ETF potentially double the cash flow of rival products.

As well as riding Wall Street’s boom in trading 0DTEs, the arrival of the ETF underscores the current insatiable appetite for products with a reliable income stream. Amid an unexpected equity rally that has defied aggressive Federal Reserve tightening, assets in derivative-selling ETFs have surged to a record by one estimate.

“Everybody is looking for that free money,” said Ayako Yoshioka, senior portfolio manager at Wealth Enhancement Group. “It fuels speculation.”

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The launch of QQQY will raise eyebrows in some quarters, as it effectively layers one controversial boom onto another. The frenzied use of 0DTEs in the past year has sparked concern over their potential threat to market stability, while flows into options-writing funds — effectively bets on market calm — are thought to be contributing to eerily subdued volatility. 

Defiance isn’t the only firm aiming to ride the 0DTE craze. ProShares filed in May to start an ETF employing the contracts, though it has yet to launch.

“0DTEs have become the hot new thing and it was only a matter of time before ETF issuers incorporated them into a fund,” said James Seyffart, ETF analyst at Bloomberg Intelligence. 

Each day, QQQY plans to sell at- or slightly in-the-money puts tied to the Nasdaq 100 with an expiration of 24 hours.

From the fund’s point of view, these amount to bullish bets on the index. Should the benchmark rise, the ETF would pocket the premiums plus a limited amount of extra upside linked to the time-value of the contracts that were sold in-the-money. 

However, if the gauge falls below the strike price of a put, the buyer of the option can demand the difference between that threshold and the index level. If that is more than the premium received by the fund, the ETF faces a loss.

QQQY will hold cash and short-term Treasuries as collateral for its derivative investments. 

Wall Street has been rushing to offer options-selling products over the past year, in part encouraged by the success of the JPMorgan Equity Premium Income ETF (JEPI). That fund outperformed the S&P 500 by 15 percentage points during 2022’s bear market, and has racked up almost $30 billion in assets in a little over three years. Money has kept flowing in despite lackluster performance in 2023. 

More than a dozen options-income ETFs have launched since this time last year, according to data compiled by Bloomberg. 

Defiance also plans to start the Defiance S&P 500 Enhanced Options Income ETF (JEPY) and the Defiance R2000 Enhanced Options Income ETF (IWMY), focused on derivatives linked to the S&P 500 and Russell 2000, respectively, according to its original filing.

“Retail and institutional investors have shown great interest in alternative income products,” said Sylvia Jablonski, co-founder and chief investment officer at Defiance. “These ETFs will seek to even further enhance the income outcomes the market has thus far experienced.”

–With assistance from Sam Potter.


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