How do options-based ETFs enhance income generation and tax efficiency?

September 10, 2025

How do options-based ETFs enhance income generation and tax efficiency?

Insight Article

How do options-based ETFs enhance income generation and tax efficiency?

September 10, 2025

In the ever-evolving landscape of investment strategies, options-based exchange traded funds (ETFs) have emerged as a compelling choice for investors seeking to refine their risk and reward profile. While these innovative vehicles may provide unique opportunities for enhanced income generation or risk management, they are often viewed as complex and opaque by both advisors and their clients. Let’s dig into their structure, investment objectives, and the market conditions contributing to their rising popularity.

Options-based ETFs are designed to cater to a range of investor objectives, primarily falling into three categories:

Protection, Income, or Growth. Most recent flows in this space have been concentrated in the protection and income categories.

Protection ETFs, including hedged equity and buffered strategies, aim to reduce downside risk in equity portfolios, smoothing returns and providing a measure of capital preservation during market drawdowns while allowing some level of upside participation. This approach may be appealing to investors concerned about potential equity market drawdowns or for those sitting on cash and looking to add equity exposure with built-in downside protection.

Income ETFs focus on generating enhanced cash flows through option-writing strategies such as covered calls. These strategies forego some of the potential upside in the underlying equity portfolio in exchange for regular distributable income, typically in the range of 5% to 10% per year¹.

This approach may be appealing to investors seeking steady income. These strategies may offer an income stream that is potentially more tax efficient than traditional fixed income investments while also being less sensitive to the level or direction of interest rates.

The market demand for options-based ETFs has surged in the past several years, potentially fueled by three primary drivers. First, elevated market uncertainty and equity valuations create heightened concerns about downside risk, prompting investors to seek strategies that provide a buffer against losses. Second, an extended period of muted fixed income yields created a strong demand for consistent yield and for strategies offering regular enhanced cash flows. Third, investors increasingly seek greater customization in their risk/return profile beyond what is available from traditional stock or bond investments.

Options-based ETFs may allow for more nuanced positioning, dialing back volatility or trading some potential upside for regular income, making them a more flexible tool for tailoring portfolios to specific objectives and risk tolerances.

Bottom Line: Options-based ETFs may present a valuable opportunity for investors seeking to enhance their portfolios with sophisticated risk management, enhanced income generation and tax efficiency, particularly in a complex financial landscape like the current environment.

For more information on Parametric Equity Premium Income ETF (PAPI) click here and for more information on the Parametric Hedged Equity ETF (PHEQ) click here.

¹Based on the competitor ETFs in the “Derivative Income” category on Morningstar. Average Trailing 12-Month Yield is 8.2% with Median at 7.67%, both within the range of 5% to 10%.

Alex Zweber

Managing Director

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