SWAN - SWAN: Where Treasuries And Call Options Combine To Create A Unique ETF

Summary

• SWAN offers a unique, simple strategy that combines a core position in US Treasury securities with call options on the S&P 500 ETF.
• This combination provides a foundation through the Treasury Notes and Bonds, with the potential for upside from the call options.
• I rate SWAN a Hold for now, but a strong hint of stabilization or decline in Treasury Note rates would likely tilt me toward a higher rating.

By Rob Isbitts

Amplify BlackSwan Growth & Treasury Core ETF (SWAN) is one of those ETFs that, when the stars align, is one of my favorite ways to be what I most enjoy being: a risk-averse equity investor, who prioritizes avoiding big losses, but wants to make as much as possible. SWAN allows investors to, as the old expression goes, have their cake and eat it too. This fairly young ETF (trading since late 2018) uses Treasuries as a stabilizer, in support of a modest SPY call option segment. In markets where interest rates are not spiking higher, but equities rally over a short period of time, this ETF can be as good a reward/risk tradeoff as any of the hundreds I closely track. Those stars are much closer to aligning than they have been in some time, so this is right point in the market cycle to zero in on SWAN as a "radar list" candidate.

Strategy

SWAN can be thought of as a US Treasury ETF, but with one unique, additional feature: call options on SPY. That latter portion of the fund provides a way to participate in bull markets for stocks, to supplement the return from the Treasuries. This ETF is based on an index, and that index is rebalanced twice a year.

ETF Grades

• Offense/Defense: Offense

• Segment: Tactical

• Sub-Segment: Option-Enhanced

Technical Ratings

• Short-Term (next 3 months): D

• Long-Term (next 12 months): D

Rating scale: A = Excellent, B = Good, C = Fair, D = Weak, F = Poor

For a detailed description of MII's proprietary technical rating system, see disclosures at bottom of this report.

Holding Analysis

SWAN holds just 8 securities. 6 of them are US Treasuries with maturities of approximately 2, 3, 5, 7, 10, and 30 years. The latter 2 maturities account for nearly 40% of assets, so this ETF has some duration risk. The other 2 holdings are call options on the SPY ETF. The expiration dates of those call options are in June and December of 2023, with strike prices of $370 and $380. SWAN's managers aim for those call options to be in the money, so they act more like a small equity position with a pre-defined loss level, since that part of the portfolio can only lose the amount invested in the call options.

Strengths

When rates crashed from around 3% at SWAN's 2018 debut to about 0.5% in 2020, SWAN went from being an interesting way to own bonds with an equity "kicker," to an ETF I could ignore for a while. After all, if the bonds pay minimal interest, the call option position, at 10% of the fund, are not enough to compensate the investor. That rendered SWAN fairly useless. But in 2023, it is anything but useless. Simply using it as a laddered Treasury portfolio would be a useful consideration. But add in those call options, and the next sharp rally in the S&P 500 would be icing on this bird's cake. And if you are counting, that's 2 cake references in this ETF.

Weaknesses

SWAN is not a perfect vehicle by any means. I would prefer to see the managers shift along the yield curve a bit more, so as to reduce the negative impact of a possible continuation of 2022's rate spike, which mutes SWAN's returns. I'd also prefer to see the call option position adjusted more frequently, perhaps quarterly, so as to stay in sync with an erratic stock market. But I'm not the manager, just a fan of this innovative and rare bird.

As this chart shows, SWAN spent 2019 looking like an intermediate-term Treasury Note, flew higher during the pandemic bounce (2020-2021) as those call options really kicked into high gear, then limped through 2022 as the bond segment's duration crushed its portfolio value.

Opportunities

There are parts of any market cycle where SWAN could be the best ETF I track. Consider the following, very realistic scenario: the S&P 500 follows its current, stubborn downtrend lower, breaking down below last year's lows and landing in the mid-3000s (that is, around 3,400-3,600), and starts to bottom. At the same time, Treasury rates start to dip, following their historically-strong rise last year. What would that do for SWAN investors? It would give them a portfolio with 90% in Treasury securities, earning around 4%, and with additional upside as rates recede.

But wait, there's more! That little 10% allocation to call options would be priced so that the subsequent market rally would likely produce a very high percentage return. That's because the call options would go from out of the money (SPY price is below the 370 and 380 strike prices) to in the money (SPY price above those strike prices). Talk about a win-win! Furthermore, the risk is contained to the portion in the call options, which can go to zero in a worst-case scenario, which would result in a 10% loss for the fund, and any loss that might occur from the Treasuries. This is not a no-loss situation by any means. But the reward potential and risk are well-balanced to me.

This is far from the only scenario that SWAN can succeed in. But the closer we get to either declining bond yields, a rising equity market, or both (which often occur at the same time), the better this ETF's chances are of delivering a competitive return for we risk-averse types.

Threats

The opposite conditions from what benefits SWAN can hurt it. Specifically, as in 2022, a sharp rise in Treasury rates across the yield curve could again produce negative returns. And, if the equity market falls or just doesn't move much higher, the call options don't add too much value. In addition, the semi-annual rebalancing brings an element of accidental timing to the SWAN equation. For instance, if the stock market falls hard just before that rebalance date, then rallies in the months that follow, the call options would re-set to being in the money instead of out of the money. That would likely produce a much smaller upside result in the calls, versus the levered impact of owning out of the money calls just prior to a strong rally.

Conclusions

ETF Quality Opinion

I sure would like to see some subtle adjustments to the SWAN methodology. But as constructed, it has plenty of opportunity to offer in this new, higher-rate, volatile stock market era. This is one ETF I am keeping close by, for when the time to strike is a bit more timely.

ETF Investment Opinion

We'll see if I get my dream scenario, or at least something approaching it. I will also add that as someone who has owned this ETF multiple times (but not as of this writing), it also makes a very nice pairing with certain ETFs that provide complementary reward/risk structures. This is clearly a case where if you spend a little time to understand a straightforward, out-of-the-box creation that is SWAN, it can be a tremendous addition to your investment arsenal. I'm at a Hold rating for now, but it won't take much to get me back on board here.

Modern Income Investor's proprietary technical rating system was created by the firm's founder, Rob Isbitts, a chartist for more than 40 years. The ratings emphasize risk-management, and the belief that while any investment can appreciate in price at any time, each investment carries a different level of potential for major loss. The balance of reward and risk is calculated each night for thousands of securities, using a formula that analyzes price trend, strength of that trend and key price levels. It analyzes data over multiple time frames to produce a short-term rating (looking 3 months out) and a long-term rating (looking 12 months out).

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