Buffer ETFs — What Are They and How Do They Work? December 16, 2025

Introduction to Buffer ETFs

Buffer ETFs are constructed using options and are also known as defined-outcome ETFs, offering investors a preset range of potential returns and risks over a typical one-year period. In other words, they’re designed to limit downside losses while still allowing you to stay invested in the market. Think of them as a way to smooth out volatility without completely giving up growth opportunities.

First Trust Vest US Equity Buffer ETF – December 2025 (FDEC)

Here’s a quick illustration:

FDEC.US offers up to 14.76% potential upside while absorbing the first 10% of market losses. This allows investors to participate in potential growth with a built-in buffer. If SPY.US finishes the outcome period with returns between 0% and –10%, the investor would not incur losses (before fees).

Overview of MAS SIP Requirements

As Buffer ETFs use more complex structures, they fall under Specified Investment Products (SIPs). This means investors must demonstrate a certain level of knowledge before trading them.

Since 2012, in alignment with the Monetary Authority of Singapore’s efforts to enhance trading protections for retail investors, brokers are required to assess an investor’s relevant knowledge and experience before permitting investments in SIPs.

As a result, investors must complete the Customer Account Review (CAR) eligibility form before being allowed to invest in listed SIPs. If you’re new to these products, you can build your understanding by completing the SIP product knowledge module offered through the SGX Academy to become eligible to trade.

How does Buffer ETFs work?

Buffer ETFs achieve their defined outcomes through the use of options strategies, primarily by combining long and short options on market indices such as the S&P 500.

By understanding how these option combinations work, you can better appreciate how the ETF is constructed and how its risk-reward profile is designed. This makes it easier to evaluate whether a Buffer ETF aligns with your investment goals, especially in volatile market conditions.

First Trust Vest US Equity Buffer ETF – December 2024 (FDEC)

The payoff structure of FDEC.US can be visualised via the risk-return chart available on the First Trust website, as well as those of other Buffer ETF issuers. The diagram illustrates how the downside buffer and upside cap interact to shape investor outcomes over the defined outcome period.

According to the fund’s Objective/Strategy section, FDEC.US aims to deliver returns (before fees and expenses) that match the price return of the SPY ETF (which tracks the SP500 index), up to a predetermined upside cap of 14.76%, while providing a 10% buffer against the first losses of the reference asset for the outcome period from 23 December 2024 to 19 December 2025.

Buffer ETFs, such as FDEC.US, typically reset annually. The options contracts that underpin the buffer-cap structure expire at the end of the outcome period, after which a new outcome period begins with newly defined cap and buffer levels, based on prevailing interest rates and market volatility.

Investors can hold the ETF through the expiry of one period and into the next; however, it is essential to note that the cap and buffer terms may vary from one period to the next.

Why Buffer ETFs Are Designed for Long-Term Investors

Buffer ETFs work best when held for the entire outcome period, as this allows the built-in options strategy to fully deliver the intended balance between downside protection and capped upside participation. Entering or exiting mid-period can result in different outcomes from those originally designed.

S&P 500 Historical Annual Returns (1927-2025)
Source: Macrotrends

Looking at the historical data, the S&P 500 has delivered strong average returns over time. While positive years are more common, market downturns can still occur, and the index is typically down by around 10% during negative periods. Therefore, Buffer ETFs may serve as a useful tool for managing downside risk, given the built-in buffer.

The Drawbacks and Risks of Buffer ETFs

1. Limited Upside (Capped Returns)

Buffer ETFs offer downside protection but cap upside potential. If the market rallies strongly, investors will not fully participate, resulting in an opportunity cost compared to traditional index ETFs.

2. Protection Only Works Within a Specific Outcome Period

Each Buffer ETF operates within a defined outcome period (typically one year). The buffer and upside cap apply only when the ETF is held for the full period, due to the structure of the underlying options.

• Selling before the end of the outcome period may lead to unexpected losses or reduced gains.
• Buying mid-cycle may result in a partially utilised buffer or a lower effective cap.

3. The Buffer Can Be “Used Up”

If the underlying index declines more than the stated buffer (e.g., a 10% buffer versus a 20% market drop), the ETF will begin to experience losses beyond the protected range. The buffer does not eliminate all downside risk.

4. Potential Underperformance in Flat or Choppy Markets

When markets are sideways or mildly volatile, the combination of capped upside and embedded options costs can cause Buffer ETFs to underperform a standard index ETF tracking the same benchmark.

5. Higher Expense Ratios

Buffer ETFs generally carry higher management fees, typically around 0.5% to 1%, compared with traditional S&P 500 ETFs, which often charge less than 0.05%.

6. Return Lag in Volatile Markets

Because Buffer ETFs are constructed using options, sharp market movements can cause pricing lag due to changes in option premiums.

For example, if the S&P 500 (SPY.US) rises 5% during a volatile period, a corresponding Buffer ETF might rise only around 4.2%, depending on where it is in its outcome period and how its options are priced.

List of Buffer ETFs

Buffer ETFs are designed to provide downside protection while allowing investors to participate in market gains, making them an attractive choice for those seeking a more controlled approach to equity investing. Below is a list of popular Buffer ETFs available in the market:

These ETFs are suited to investors seeking strategic market exposure with controlled risk, particularly in volatile market environments.

Should You Invest in a Buffer ETF?

Buffer ETFs can be an attractive choice for investors looking to gain exposure to equity markets while actively managing risk. These ETFs offer built-in downside protection, which can help mitigate the impact of moderate market declines and provide clearly defined potential gains and losses over a fixed outcome period.

They are particularly suited for investors with a tactical investment approach who intend to hold the ETF for the full outcome period to fully benefit from the buffer structure. By tracking major indices such as the S&P 500 or the Nasdaq 100, Buffer ETFs also offer diversified exposure to both US and international equities.

However, investors should be aware that the upside returns are capped, meaning they may miss out on large market rallies, and that early exits or mid-cycle purchases can reduce the effectiveness of the protection. In addition, higher expense ratios and embedded option costs can slightly impact returns compared with traditional ETFs.

Overall, Buffer ETFs are best viewed as a complement to a broader investment portfolio, offering a balance between growth potential and controlled downside risk, particularly in uncertain or volatile market conditions.

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