Download complete issue - IndexUniverse.com

More documents

Recommendations

Info

equired to establish this position and is the basis for all gain/loss calculations. The vertical bull put spread is a neutral-to-bullish multileg options strategy (Figure 4). Premium is collected through the sale of a put (obligation to receive the underlying stock). Part of the premium received is used to buy a put (right to sell the underlying stock) at a lower strike price. Selling a put theoretically represents risk equal to the contract strike price. Buying a put limits the risk to the difference between the sold and bought strike prices (strike spread) less any premium collected. For example: SLD: SPY NOV 140 PUT @ 4.55 (receive $455) BOT: SPY SEP 137 PUT @ 3.45 (pay $345) Net Credit: $455 - $345 = $110 $-At-Risk: Difference in Strikes – Net Credit ((140 – 137) x 100) - $110 = $190 MAX Gain/Loss: Max Gain = $110 (36.67%) / Max Loss = $193 (-63.33%) Collateral for this position would generally be determined by the strike spread. Collateral of $300 would be required to establish this position and is the basis for all G/L calculations. Benchmarking Options Strategies The spreads described here are typical in that this trade is usually constructed to sell the ATM and use the proceeds to purchase insurance a certain percentage away from ATM. This is a classic, risk-controlled trade. ISE took the framework of this trade and blended it with modern portfolio theory to develop a truly diversified portfolio of vertical spread trades to help transform a trading vehicle into a potential investment vehicle. Spread pairs that are very close to or ATM are more likely to have the underlying stock trade through them and incur maximum losses (high delta/low gamma). Pairs that are further away from ATM are less attractive from a net credit perspective, but require larger moves of the underlying to put the position at risk (mid delta/ mid gamma). Pairs that are quite far away from ATM exhibit higher levels of price volatility (low delta/high gamma) due to the low absolute-price levels at which they trade. Being positioned too close or too far away from ATM presents unique risks for each. We identified optimal spreads from each of these categories and combine them into a single basket. In doing so, we created the ISE SPY Bear Options Overlay Index (VCS) and the ISE SPY Bull Options Overlay Index (VPS). The ISE Options Overlay indexes provide benchmarks for investors looking to track the performance of a diversified portfolio of exchange-listed options utilizing the vertical spread strategy. As indicated by the name, each index solely includes option contracts on the SPDR S&P 500 exchange-traded fund (NYSE Arca: SPY). Figure 5 Vertical Put Spread Loss-Floor Example SPDR S&P 500ETF 128 126 124 122 120 118 116 114 112 110 Nov 10 2011 Expiration Date Nov 17 2011 Nov 24 2011 Dec 1 2011 Dec 8 2011 Expiration Date Dec 15 2011 Dec 22 2011 Dec 29 2011 260 255 250 245 240 235 230 225 220 215 210 ISE Bull Options Overlay Index ■ SPY ■ VPS High-Low-Close Source: Bloomberg Figure 6 Trading Trade Date Symbol One Day SPY Price Move # 3-Month Of Spread Average Pair Components Daily Volume # Of Spread Pair Components Allocated To Cash Proxy 11/18/2011 - Index Rebalance Date -1.90% 50 0 Source: Livevol Loss-Floor Mechanism 11/22/2011 -0.39% 47 3 11/23/2011 -2.21% 20 27 11/25/2011 -0.19% 14 6 12/16/2011 – Final Day of Period 0.14% 14 0 www.journalofindexes.com November / December 31
The following steps are taken to select spread pair components for each index: i) Establish total population of available SPY option contracts for the front and second month. ii) Refine selection universe based on eligibility/liquidity requirements. iii) Create all possible ATM vertical spread pairs. iv) Create and equal-weight overall rank for each pair by calculating and ranking on various criteria based on factors such as strike spread and net credit. v) Based on the sold leg of each spread, determine the distance away from ATM (money-ness). vi) Allocate spread pairs along proprietary money-ness and expiration criteria. vii) Apply an equal weighting to all spread pairs. Index components are evaluated using bid/ask pricing. Midpoint pricing is used for the real-time and end-of-day index level calculation. The index is rebalanced monthly in conjunction with the regular options expiration calendar. To manage downside volatility, each index employs loss floors at the individual spread level. Once a spread pair has priced through the floor on an end-of-day basis, the component’s weight in the index is allocated away from the spread pair and moved to a cash proxy until the next rebalance cycle. While this approach is effective in managing downside risk over a few days or in between rebalance cycles, it is ineffective in controlling any oneday market event. Managing downside risk in this manner not only limits losses but mitigates the risk of any positions being assigned and forcing the delivery of shares of the underlying for any investor following the index. Figure 5 shows this loss floor in action. This graph highlights the complete options cycle for December 2011 (11/18/2011 to 12/16/2011). In the December period, SPY trades off early in the cycle and we see the bullish index trading off as well. What is hidden is the loss-floor mechanism. Figure 6 provides an analysis of index components during this period. The loss-floor mechanism allows for those positions that could cause more drag on performance to be allocated to cash, and without significant lag. It sometimes is the case with sharp moves in SPY that the entire index spends some time during the expiration cycle allocated completely to the cash proxy, but as mentioned earlier, the cash proxy weight is reallocated to new spread pairs in the next rebalance cycle. The example given represents one period and is unique, meaning it will not always be the case that a -2.21 percent move in SPY will result in 27 spread pairs being reallocated to the cash proxy, or more generically, that an aggregate move of X percent in the underlying will always result in a particular action occurring in the index. Unlike other options strategy indexes, these indexes solely include options contracts and do not contain any underlying security as a component. In designing these indexes, we realized that investors looking for optionoverlay products wanted just that—an option overlay. It did not make sense to force investors to double-up on Figure 7 Figure 8 Dates Source: Bloomberg Performance Comparison SPY (Equity) VCS (Index) VPS (Index) 01/21/2005 – 12/31/2005 8.50% -30.93% 32.30% 12/31/2005 – 12/31/2006 15.85% -43.93% 55.95% 12/31/2006 – 12/31/2007 5.14% 62.80% -35.15% 12/31/2007 – 12/31/2008 -36.81% 225.41% -12.77% 12/31/2008 – 12/31/2009 26.37% 1.26% 19.62% 12/31/2009 – 12/31/2010 15.06% -60.81% 53.78% 12/31/2010 – 12/31/2011 1.89% -52.49% 16.50% 12/31/2011 – 8/31/2012 13.54% -43.76% 38.57% Source: Bloomberg Historical Index Performance, January 2005-August 2012 450 400 350 300 250 200 150 100 50 0 1/21/05 1/21/06 1/21/07 1/21/08 1/21/09 1/21/10 1/21/11 1/21/12 ■ VCS Index ■ VPS Index ■ SPY US Equity the existing underlying stock positions or have to incur transaction costs or create taxable events in order to get exposure to these strategies. Figure 7 shows some periodic returns of each of the indexes as compared with the underlying (SPY) for each calendar year since the indexes’ inception. Figure 8 shows the historical trend lines for the indexes versus SPY. While the indexes’ base dates are both Jan. 21, 2005, the indexes commenced operation on Sept. 16, 2011, and all prior index levels are backtested. As component selection for these indexes is a purely quantitative process, there should be no concerns regarding survivorship bias or other forms of “cherry-picking” that could influence any backtested results. The base date of Jan. 21, 2005 was chosen as it was the date that ISE and the other U.S. options exchanges first listed options contracts on SPY. The development of the VCS and VPS indexes began as an academic exercise, but they have real-world potential to help investors gain exposure to options in a sophisticated—yet straightforward—approach. Composed of option contracts that are centrally cleared, exchange listed, continuously quoted and among the most liquid and heavily traded contracts in the marketplace, the indexes could provide investors access to a truly unique and useful way to express their opinions on the market. 32 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 24 and 25: Figure 6 $15 $12 $9 $6 $3 5 Indexes
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 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
Page 56 and 57: of health care services, primarily
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

Download complete issue - IndexUniverse.com

Create successful ePaper yourself

Delete template?

Save as template?