Single-Stock Leveraged ETF Scare! Investment Banks Like Goldman Sachs and Citigroup Deploy "Market Crash Options" to Transfer Tail Risk, Offering Annualized Returns of Up to 20%

As the asset size of global leveraged ETFs approaches $250 billion, the large banks providing swaps and leverage support are increasingly relying on a special type of over-the-counter derivative—the "Market Crash Option" (Crash Put)—to hedge against tail risks during extreme market conditions.

According to Bloomberg, major investment banks including Goldman Sachs, Barclays, Citigroup, and BNP Paribas are already active in this market. Since the beginning of this year, demand for these derivatives has heated up significantly alongside the rapid expansion of leveraged ETF scales. Meanwhile, Goldman Sachs has even promoted related trades with annualized returns as high as 14%-20% to institutional clients, attracting more hedge funds and asset management firms to act as market "insurers."

However, as the market scale expands rapidly, this highly customized derivatives market with limited transparency has begun to raise concerns within the industry regarding financial stability. Some fund managers have warned that the layered risk transmission mechanism among leveraged ETFs, over-the-counter swaps, and market crash options could amplify systemic shocks during extreme market conditions.

Why Have Market Crash Options Suddenly Become Popular?

So-called "Market Crash Options" (Crash Puts) are essentially over-the-counter derivatives that provide banks with protection against tail risks. Their emergence stems from the inherent "Gap Risk" of leveraged ETFs.

Taking a 2x leveraged ETF as an example, if the underlying stock falls by more than about 50% in a single day, the fund's net asset value could drop to nearly zero. As the counterparty in the swap transaction, the bank might then be unable to recover all losses from the ETF issuer.

Market crash options are designed specifically for this extreme scenario. Banks pay premiums to external investors; when the underlying stock experiences an unexpected plummet, the buyer bears the corresponding losses, thereby transferring the tail risk.

Ramon Verastegui, Founder and Chief Investment Officer of Kairos Investment Advisors, stated that this is essentially an efficient "back-to-back" risk transfer tool. Rocky Fishman, Founder of Asym Research, described it as follows: its return profile is similar to high-yield bonds—investors continuously collect substantial yields until one day they encounter an extreme event.

The Hotter Leveraged ETFs Get, the Greater the Banks' Hedging Demand

The surge in demand for market crash options is driven by the explosive growth of the leveraged ETF market over the past two years.

Bloomberg data shows that the current global asset size of leveraged ETFs is approaching $250 billion, with over 700 products in the US market alone. Although the assets under management in the US market retreated to around $160 billion after touching approximately $200 billion in June, the overall level remains at a historical high.

Among these, high-volatility individual stocks such as SK Hynix, Micron, NVIDIA, and Tesla have become the most popular underlying assets for leveraged ETFs. Fishman noted that the volatility of stocks underlying many 2x single-stock leveraged ETFs reaches three to five times that of the Nasdaq 100 Index, making it even more difficult for banks to manage the tail risks of these products compared to 3x leveraged index ETFs.

The South Korean market has become a representative case of concentrated risk. Although the South Korean stock market has a 30% daily price limit, since market crash options are settled based on the official closing price, consecutive daily limit-downs can still result in cumulative multi-day declines that trigger huge losses for banks. Consequently, South Korean regulators have begun to further tighten restrictions on retail participation in leveraged ETF trading.

High Yields Attract Institutions to Compete as "Insurers"

Rapidly growing demand has also pushed up the risk premium for market crash options.

According to reports, promotional materials from BNP Paribas showed that in May of this year, the premium for a single-day gap put option on SK Hynix, with a strike price of 55% of the stock price and a maximum term of six months, reached 6.5%, while the corresponding product for Samsung Electronics reached 5.5%. In March of this year, these figures were only 3.5% and 2%, respectively.

During the same period, Goldman Sachs promoted related trades to clients that, when using leverage, offered expected annualized returns of 14.2%-20%.

Natasha Sibley, Portfolio Manager of the Alternative Investment Team at Janus Henderson, stated that this is one of the periods of strongest demand she has ever seen. "Banks are eager to transfer risk out, and the continuously rising yields are attracting more and more investors to provide insurance."

As the market matures, these strategies are also moving towards productization. In April this year, Janus Henderson launched two actively managed structured return ETFs, JELH and JELM. By utilizing stable swaps and equity-linked notes, these ETFs encapsulate structured strategies originally available only to institutional investors, thereby further expanding the potential investor base.

Risk Transfer Does Not Mean Risk Disappearance

However, several industry insiders believe that market crash options merely redistribute risk without truly reducing the risk level of the entire financial system.

Since these products are primarily traded over-the-counter, lacking public and transparent data disclosure, it is difficult for the market to accurately assess the overall risk exposure. Owen Lamont, Portfolio Manager at Acadian Asset Management, warned that historical experience indicates that the combination of leverage, multiple counterparties, and complex financial innovations often tends to amplify systemic risk.

According to statistics from Asym Research, in the US listed leveraged index ETF swap market, Barclays, Citigroup, Goldman Sachs, and Bank of America each hold more than 10% of the market share; in the leveraged single-stock ETF swap market, Clear Street holds approximately 20% of the market share, followed closely by Nomura and Goldman Sachs.

As leveraged ETFs continue to expand, the network of over-the-counter derivatives formed around them, including swaps and market crash options, will also further expand. Whether this market can effectively disperse risk or will amplify shocks during extreme market conditions is becoming a question of increasing concern for regulators and market participants alike.