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Figure 6 $15 $12 $9 $6 $3 5 Indexes Since Mid-1986 (June 30, 1986 - July 31, 2012) $- 6/86 6/94 6/02 6/10 ■ PUT - CBOE S&P 500 PutWrite ■ S&P 500 ■ BXM - CBOE S&P 500 BuyWrite ■ CLL - CBOE S&P 500 95-110 Collar ■ MSCI EAFE (US$) Sources: Bloomberg and CBOE Total Return Indexes Re-scaled To $1 On June 30, 1986 $13.40 $10.03 $9.86 $4.90 $4.63 related to limited liquidity and transparency, and the negative impact of the actions of other investors in the fund—sometimes referred to as co-investors. For example, representatives from one plan reported they were unable to cash out of their hedge fund investments due to discretionary withdrawal restrictions imposed by the fund manager, requiring them to sell some of their stock holdings at a severe loss in order to pay plan benefits. 4 In addition, Daniel Wallick, principal, Vanguard Investment Strategy Group, was quoted: Liquidity was largely ignored before the 2008 crisis. A lot of endowments had liquidity problems because their portfolios were heavily weighted to private equity and capital calls had to be met. The situation back then has made a lot of endowment CIOs consider the impact of alternatives on their portfolios now. 5 Index Option Writing And Benchmark Indexes In light of the four challenges listed above, in the past decade, many investors have explored the potential of using relatively liquid index option-writing strategies in order to add gross income, and to enhance risk-adjusted returns for their portfolios. In the years 2000 and 2001, some options-based investment managers requested that the Chicago Board Options Exchange (CBOE) create some options-based benchmark indexes, and CBOE did so in subsequent years. The remainder of this paper will analyze the performance of four benchmark indexes that sell one-month, cash-settled S&P 500 (SPX) Index options on the third Friday of every month 6 (see Figure 5). Certain options-based portfolio managers have said that a long-term aspirational goal of the buy-write strategy is to achieve higher “stocklike” returns and lower “bondlike” volatility. Does past performance of options-based benchmark indexes suggest this goal has been achieved at times? In the time period from June 30, 1986 through July 31, 2012, the PUT Index rose 1,240 percent, the S&P and BXM indexes both rose about 900 percent, and the CLL and MSCI EAFE (in $US) indexes both rose more than 360 percent (see Figure 6). The BXY Index is not included in Figure 6 because its backtested price history begins in mid-1988. As shown in Figures 7 and 8, over a recent 20-year period, (1) the PUT and BXY indexes both had higher returns and lower volatility than the S&P 500, MSCI EAFE and S&P GSCI indexes; and (2) three optionsbased indexes (PUT, BXM and CLL) had less volatility than the Treasury bond index and the two stock indexes. Figure 9 shows the risk-adjusted returns and other statistics for the four options-based indexes highlighted in this article as compared with other widely referenced benchmarks. In Figure 10, the three options-writing indexes (PUT, BXY and BXM) all are favorably positioned to the northwest, with higher returns and lower volatility than the MSCI World and S&P GSCI indexes. Two questions that have been asked are as follows: (1) If the PUT and BXM indexes both have had about 70 percent of the volatility of the S&P 500 Index, and if the indexes have been fairly priced for risk and return, why haven’t the PUT and BXM indexes also had about 70 percent of the returns of the S&P 500 Index over longer time periods? Figure 7 PUT - CBOE S&P 500 PutWrite Index BXY - CBOE S&P 500 2% OTM BuyWrite 30 Yr T-Bond Index (Citi) S&P 500 BXM - CBOE S&P 500 BuyWrite Index CLL - CBOE S&P 500 95-110 Collar Sources: Bloomberg and CBOE Figure 8 Annualized Returns Over 20 Years MSCI EAFE (US$) S&P GSCI (July 31, 1992 - July 31, 2012) Total Return Indexes PUT - CBOE S&P 500 PutWrite Index CLL - CBOE S&P 500 95-110 Collar BXM - CBOE S&P 500 BuyWrite Index 30 Yr T-Bond Index (Citi) BXY - CBOE S&P 500 2% OTM BuyWrite Sources: Bloomberg and CBOE 3.5% 5.5% 5.5% Standard Deviations Over 20 Years S&P 500 MSCI EAFE (US$) S&P GSCI 10.7% 10.8% 11.0% 12.8% 12.8% (July 31, 1992 - July 31, 2012) Total Return Indexes 15.1% 8.3% 8.2% 8.2% 17.1% 9.7% 9.4% 21.7% www.journalofindexes.com November / December 2012 23
Figure 9 Metrics for Returns, Risk and Risk-Adjusted Returns (June 30, 1988 - July 31, 2012) BXM BXY PUT CLL S&P 500 MSCI EAFE 30-Year Treasury Barclays US Agg Return 9.44% 10.56% 10.82% 6.14% 9.35% 4.38% 8.86% 7.29% Standard Deviation 10.63% 12.45% 10.12% 10.77% 14.97% 17.84% 12.29% 3.81% Beta vs. Market 0.63 0.78 0.56 0.66 1.00 0.87 -0.07 0.04 Skewness -1.31 -0.92 -2.00 -0.13 -0.57 -0.40 0.24 -0.25 Kurtosis 4.61 2.57 9.07 -0.29 1.08 0.90 3.33 0.58 Sharpe Ratio 0.57 0.58 0.72 0.27 0.43 0.13 0.46 0.93 Semi Standard Deviation 0.09 0.10 0.08 0.08 0.11 0.13 0.09 0.03 Sortino Ratio (MAR = Cash Eq.) 0.72 0.79 0.90 0.36 0.59 0.15 0.69 1.38 Jensen’s Alpha vs. S&P 0.02 0.02 0.04 -0.01 0.00 -0.03 0.06 0.03 Source: Ibbotson & Associates Note: The BXM, BXY and PUT indexes had risk-adjusted performance that was superior to that of the S&P 500 per metrics such as the Sortino ratio, Sharpe ratio and Jensen’s alpha. Most of the above indexes had negative skewness, and the measures of risk-adjusted returns are imperfect when measuring non-normal distributions. (2) Why were the risk-adjusted returns of the CLL (collar) index so much weaker than the other three optionsbased indexes (PUT, BXM and BXY)? Source Of Strong Risk-Adjusted Returns: S&P 500 Options Have Been Richly Priced One answer to the two questions posed above is that one can look at Figure 11 and the comparison of implied 500 95-110 Collar Index (CLL) has not had relatively strong risk-adjusted returns because of the fact that the CLL Index is both a buyer of (richly priced) put options and a seller of (richly priced) call options. As interest rates for U.S. fixed income have declined, investors continue to search for instruments with higher yields. A yield-based strategy that has grown in popularity over the past decade is the “buy-write” strategy, A yield-based strategy that has grown in popularity over the past decade is the “buy-write” strategy, in which an investor could buy securities and write (or sell) options on those strategies. and realized volatility. If the markets were very efficiently priced, one could expect that there would be little to no difference between the implied and realized volatility over the long term. However, the average difference in Figure 11 was about 3.8 volatility points, a substantial number. Several other studies 7 also have found significant differences between implied and realized volatility. Why has there been a difference between implied and realized volatility? Professor Robert Whaley wrote: … there is excess buying pressure on S&P 500 index puts by portfolio insurers. Since there are no natural counterparties to these trades, market makers must step in to absorb the imbalance. … implied volatility will rise relative to actual return volatility. … The implied volatilities of the corresponding calls also rise from the reverse conversion arbitrage supporting put-call parity. 8 While the three indexes that incorporate option selling (PUT, BXM and BXY) into their methodologies appear to have benefited from the fact that implied volatility usually has been higher than realized volatility, the CBOE S&P in which an investor could buy securities and write (or sell) options on those securities. The most well-known benchmark for the buy-write strategy—the CBOE S&P Figure 10 Annualized Returns 12% 10% 8% 6% 4% Returns And Volatility Over 20 Years (July 31, 1992 - July 31, 2012) 10-Yr Treasury 1-Yr Treasury PUT BXM CLL BXY 30-Yr Treasury S&P GSCI 2% 0% 5% 10% 15% 20% 25% Standard Deviation S&P 500 Sources: CBOE, Bloomberg, Citigroup Fixed Income Indexes MSCI World Russell 2000 24 November / December 2012
Page 1 and 2: Plus Blitzer on the history of opti
Page 3: Contributors Mark Abssy Mark Abssy
Page 6 and 7: STOXX LIMITED INNOVATIVE INDEXING.
Page 8 and 9: People’s futures are in your hand
Page 10 and 11: ©2012 Morningstar, Inc. All rights
Page 12 and 13: Exchange-traded products span a wid
Page 14 and 15: Figure 5 Median notional Volume ($B
Page 16 and 17: the put spread in this example is $
Page 18 and 19: The Loch Ness Monster. Sightings of
Page 20 and 21: TAKE A NEW LINE WITH YOUR EQUITY Po
Page 22 and 23: Over the past 12 years, U.S. invest
Page 26 and 27: 500 BuyWrite Index (BXM)—was anno
Page 28 and 29: volatility that was about 30 percen
Page 30 and 31: Most investors are familiar with op
Page 32 and 33: equired to establish this position
Page 34 and 35: THE POWERSHARES DB COMMODITY INDEX
Page 36 and 37: Depression was history, rather than
Page 38 and 39: academic assessment of the very exi
Page 40 and 41: Alternative Investments 4.0% Real E
Page 42 and 43: tion and management. Within it, an
Page 44 and 45: Much ink has been spilled on the pe
Page 46 and 47: Figure 1 sectors No. of top dogs Re
Page 48 and 49: over the 30-year span. “Business
Page 50 and 51: States, the average concentration p
Page 52 and 53: Figure 10 sectors Source: Research
Page 54 and 55: investors were charging, ProShares
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Page 58 and 59: open the Etracs Long-Short S&P 500
Page 60 and 61: Morningstar Index Funds U.S. Style
Page 62 and 63: Exchange-Traded Dow Jones U.S. Indu
Page 64 and 65: ETF Analytics Your clients want mor
Page 66 and 67: PICK THE HIGH HANGING FRUIT. Find 1
Page 68 and 69: InsideETFs portFolio management str
Page 70 and 71: ©2012, THE NASDAQ OMX GROUP, INC.
Page 72: Crossword Thinking About Options Te

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