Market

ARKK ETF Hit Support, Get A 10% Discount

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Thesis

The ARK Innovation ETF (NYSEARCA:ARKK), a poster child of an overvalued technology and innovation market in 2021, has experienced a violent re-pricing this year, being down almost 60%. However, despite its significant underperformance versus the broader market, the fund is seeing robust inflows, with eight straight days of additions and an amount of over $600 million poured into the fund. It seems that investors who once tripled their money by investing with Cathie Wood after the Covid crisis believe the good times will be back and 2023 will see a resurgence of interest in technology companies. We are of a different opinion. We do not believe that tech will see a V-shaped recovery, and that the P/E debasing we are witnessing is here to stay until the excess capital that was poured into the sector is fully crunched. That being said, from a technical standpoint ARKK is beginning to bottom out with a tentative base being established at the long term support level of $40/share. This price level has provided a technical support level for ARKK since 2018:

ARKK Price Level

ARKK Price Level (Seeking Alpha)

With continued belief in the fund, we feel a retail investor would be best served to take advantage of a covered put strategy to enter ARKK. Specifically, we feel the volatility exposed by ARKK coupled with the rich option premium can be used to an investor’s advantage to get a substantial discount to the current spot price. By underwriting short-dated 2 month cash covered puts, investors can obtain discounts of 10%+ to the current price or realized annualized yields of over 50% if the strategy is rolled over successfully at the same premium levels.

What is the Trade

An investor can sell September 2022 cash covered puts at a $40 strike for a premium of $4.25 per contract:

ARKK Cash Covered Puts Details

Cash Covered Puts Details (Author)

The above table describes a hypothetical trade with 10 contracts (10 contracts x 100 shares = 1,000 ARKK shares) and a September 16, 2022 maturity date. An investor would receive on day 1 a cash amount of $4,250 which would be the option premium at the current implied volatility of 65% for the chosen strike and expiry date. If the trade expires without being triggered (i.e. the price is higher than the strike upon expiry), assuming a hypothetical “roll” of the trade for the rest of the year at the same terms results in an annualized yield exceeding 50%.

Below, an investor can find the full option chain for the September 16, 2022 maturity date, courtesy of Market Chameleon:

ARKK options

Option Chain (Market Chameleon)

Depending on risk appetite and views on ARKK an investor can engage in a cash covered put strategy at different strike levels outside the long term support of $40/share.

The strategy can result in different outcomes, depending on where the price ends up on September 16, 2022:

Scenario 1:

  • ARKK’s price on September 16, 2022 is above $40/share.
  • The sold put expires without being triggered.
  • The investor pockets the premium of $4,250 without further obligations.
  • By rolling this strategy at the same terms, an investor can theoretically realize a net annual premium of over $20,000, which represents an annualized yield of over 50% given the maximum cash out the door of $40,000.

Scenario 2:

  • ARKK’s price on September 16, 2022 is below $40/share
  • The sold put gets triggered upon expiry since the price is below the strike level
  • The investor realizes a net buy price of $35.75 (strike minus option premium), which represents a discount of over 10% from current spot levels for ARKK
  • The net buy price is below the long term support level

When an ETF experiences significant volatility and an investor wants to purchase said vehicle as a long term investment, it is always a good idea to layer in via cash covered puts since it represents a much better priced alternative to just buying outright. The fact that one should not expect a V-shaped recovery in ARKK is also a further impetus to utilize the high volatility to one’s advantage. Buying outright provides the full upside if the respective ETF rallies right away, but if a protracted period of consolidation is expected, then the outright buy benefits are muted.

Conclusion

ARKK has experienced significant volatility in 2022 and has lost investors nearly 60% of their capital. From a technical standpoint, ARKK looks like it is forming a bottom at the long term support level of $40/share. Despite its poor performance year to date, investors have not lost faith in ARKK, with solid inflows into the vehicle in the past weeks. We feel a retail investor who is interested in ARKK as a long term holding is best served in the current volatility environment to pursue a cash covered put strategy where short-dated puts are underwritten at the long term support level of $40/share. Engaging in this strategy can result in purchases prices that offer a 10% discount to current spot levels or annualized yields in excess of 50%.

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