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500 BuyWrite Index (BXM)—was announced in 2002.
The BXM Index assumes that slightly out-of-the-money
S&P 500 options are written on the third Friday of every
month, and the average gross monthly yield for the BXM
Index (using the premium received as a percentage of
the underlying) has been about 1.8 percent. Figure 12
shows the rolling 12-month gross premiums for the BXM
Index, and the rolling 12-month net returns for both the
BXM Index and S&P 500 Index. In Figure 12, note that
the BXM net return has been pretty close to the BXM
gross premiums in times of steadily rising stock markets.
However, in years in which the S&P 500 has experienced
big drops (e.g., 2001 and 2008), the BXM net return was
generally above that of the S&P 500, and far below the
BXM gross premiums as a percentage of the underlying.
Managing Of Left-Tail Risk And ‘Black Swan’ Events
After witnessing two big declines in stock index values
since the year 2000 (see Figure 2), many investors in
recent years have heightened concerns about left-tail risk
and catastrophic “Black Swan” events that could harm
Figure 11
Diference in Volatility Points
Figure 12
80%
60%
40%
20%
0%
-20%
-40%
10
5
0
-5
-10
Implied Volatility (VIX) Minus Subsequent
SPX Realized Volatility
(SPX Options Usually Have Been Richly Priced)
-15
6/90 6/93 6/96 6/99 6/02 6/05 6/08 6/11
(June 8, 1990 - July 20, 2012) Rolling 6-month average of the spread between
end-of-week VIX and the subsequent 30-day SPX realized volatility
Sources: Bloomberg and CBOE
Rolling 12-Month Gross Premiums
And Net Returns
-60%
6/89 6/92 6/95 6/98 6/01 6/04 6/07 6/10
BXM Gross Premiums ■ BXM Net Return ■ S&P 500 Net Return
(June 1989 – July 2012)
Sources: Bloomberg and CBOE
Note: BXM gross premiums are received every month and are expressed as annualized
% of the underlying S&P 500 Index. Net returns are for total return indexes.
Figure 13
160
120
80
40
0
-24% to
-20%
Tail Risk And Frequency Of Monthly Returns
(July 1986 - July 2012)
40
2624
10
11
1 0 1 0 1 0 1
2 1 0
-20% to
-16%
-16% to
-12%
-12% to
-8%
■ S&P 500
-8% to
-4%
105
-4% to
0%
140
127
0% to
4%
■ CLL Index (collar)
4% to
8%
8% to
12%
12% to
16%
During the 26-year time period, the S&P 500 Index had 13 months with returns
worse than -8%, while the CLL Index had only one such month.
Sources: Bloomberg and CBOE
their investment portfolios. An options strategy that could
be explored by risk-averse investors is the “collar” strategy,
in which one purchases stock, buys protective put
options for downside protection and sells covered calls
for income that can help pay for the put premiums. A key
benchmark for the collar strategy is the CBOE S&P 500
95-110 Collar Index (CLL), which buys S&P 500 puts for
downside protection, and sells S&P 500 calls for income.
Note that in Figure 13, the CLL Index was able to lessen
much of the left-tail risk. During the 26-year time period,
the S&P 500 Index had 13 months with returns worse than
-8 percent, while the CLL Index had only one month with
a return worse than -8 percent.
Correlations And Diversification
Over the past decade, many investors have become
more concerned about challenges to diversification, as
there have been increasingly higher correlations among
“traditional” investments. As shown earlier in this paper, in
Figure 4, the correlations of weekly returns versus the S&P
500 for various indexes were:
• 0.96 for the Russell 2000
• 0.88 for the MSCI EAFE
• -0.84 for the CBOE VIX Index
Figure 14 shows correlations among various indexes. The
BXM, BXY, PUT and CLL all hold the S&P 500 stock basket,
and so it is not surprising that all four of those indexes had correlations
of 0.89 or higher versus the S&P 500 Index during the
time period. The BXY Index writes out-of-the money (OTM)
S&P 500 options, and so it can rise and fall with the S&P 500
Index (up to 2 percent up during the monthly time period). Not
surprisingly, the correlation of the BXY and S&P 500 was 0.95.
The CBOE S&P 500 95-110 Collar Index (CLL) buys S&P
500 protective puts for protection. Even though the CLL
Index and S&P 500 Index had a 0.89 correlation in Figure
14, there also is evidence (in Figure 13) to suggest that the
CLL Index can help provide some protection when the
stock markets suffer big drawdowns.
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