How derivatives may change market dynamics

The ETF industry has waded into a new area of opportunity.

A regulatory change from the Securities and Exchange Commission last year opened up the use of derivatives for investment vehicles such as exchange-traded funds. Previous regulation had limited the way in which funds could offer products with “potential future payment obligations.”

Simplify ETF has taken advantage of the rule change. Paul Kim, CEO and co-founder, joined CNBC’s “ETF Edge” to discuss how.

“We’re trying to democratize the access to sophisticated capabilities and portfolio tools that traditionally have been only available to the largest institutional investors like hedge funds, i.e., things like access to OTC derivatives,” Kim said on Monday.

Two of Simplify’s ETFs that aim to do this include the QQC Nasdaq 100 Plus Convexity ETF and the QQD Nasdaq 100 Plus Downside Convexity ETF. Both mirror the Nasdaq 100 while also deploying an options strategy to offset sell-offs. They have been active since December and are up 7% this quarter.

“You’ve opened up sort of the last hurdles that differentiate an ETF vehicle from other vehicles – so if the hedge fund vehicle itself took advantage of greater flexibility to use leverage and use derivatives and be more flexible and nimble, now the ETF [can],” Kim added.

Dave Nadig, director of research at ETF Database, on Monday called these derivative ETFs among the “most interesting things going on in the ETF industry.”

“Most of the interesting product innovation is using multiple asset classes to generate new patterns of return. We don’t need more vanilla equity funds, we don’t need more vanilla bond funds, we do need better solutions for people trying to solve real problems like generating income,” Nadig said.

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