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How does a buffered ETF work?​

Buffered ETFs combine traditional investing with options contracts to control the range of possible investment outcomes. At the heart of the product is a reference fund, in the case of the ARK Defined Innovation Exposure Term (“ARK DIET”) Buffered ETF, ARKK – the ARK Innovation ETF, is the investment it tracks.
 

Here’s how it works: 

  • Limited Downside Protection ("The Buffer") – The ETF uses put options to protect against part of the losses. A put option gives the right to sell the reference fund at a set price. This limits how much the ETF can lose if the reference fund drops. 
  • Upside Participation (With a Hurdle) – The ETF sells call options and uses the premium (money received) to fund the protective put. The sold call option limits gains by capping how much profit the investor can receive beyond a certain point. 
  • Outcome Period – The investment is designed to work over a fixed 12-month period. The buffer and upside participation rate are set at the beginning and apply to that year. 

In the ARK DIET products, for example, if ARKK declines by 20%, the ETF would be expected to fall by about 10% (the buffer). On the upside, the ETF will skip the first 5% of gains (a hurdle), then give the investor generally 50-80% of gains beyond that.