SPX Options for Higher Yields When Interest Rates Are Low

Many investment professionals today feel challenged in their search for safe liquid investments with strong yields that can help boost risk-adjusted returns for their portfolios. Many investors are re-examining traditional fixed income investments and option-writing strategies using options on the S&P 500® Index (SPX) www.cboe.com/SPX and other securities.


Key interest rates in the Wall Street Journal today (August 20th) included:

0.11% — 4-week U.S. Treasury bills

0.44% — 3-month LIBOR

1.41% — 5-year CD

1.82% — 10-year U.S. Treasury notes

1.95% — Barclays Capital Aggregate

5.93% — Merrill Lynch High-yield 100

A recent news story noted —

“… skeptics say the ravenous demand for corporate bonds has pushed yields on the securities down too far to compensate investors for their risk. …When interest rates eventually rise, prices of recently issued corporate bonds will fall. ‘The guy buying a [new] bond today is a guy buying a certain loss,’ says Anders Maxwell, a managing director at investment bank Peter J. Solomon Co. ‘Rates have to go higher, and when they do these low-coupon bonds will drop precipitously in value.’ …” From: “As Corporate-Bond Yields Sink, Risks for Investors Rise” (August 14, 2012) www.wsj.com

In an op-ed piece in the March 22, 2012 Wall Street Journal, Princeton University economist Burton Malkiel wrote that —

“ … Bonds are the worst asset class for investors. Usually thought of as the safest of investments, they are anything but safe today. At a yield of 2.25%, the 10-year U.S. Treasury note is a sure loser. …”


As interest rates for traditional fixed income investments have fallen, many investors are seeking other investments to generate higher yields. Among the many strategies to generate income

CBOE calculates five buywrite benchmark indexes that are designed to show the hypothetical performance of a strategy that holds a stock index portfolio and writes (or sells) index options for income once a month, usually mid-day on the third Friday www.cboe.com/buywrite

The table below shows the options premiums and the approximate underlying index levels for all five of the CBOE’s buywrite benchmark indexes at the time of the “roll” on August 17. At the time of the roll, the CBOE Volatility Index® (VIX®) was at a relatively low level of 14.7. www.cboe.com/VIX Options premiums for the buywrite indexes often are lower when VIX is lower.

Four of the indexes (BXM, BXD, BXR, and BXN) write options that are just slightly out-of-the-money (OTM), while the BXY Index writes options that are 2% OTM. Compared to the other 4 indexes, the BXY Index generally has more upside potential for its underlying stock position, but the BXY Index also has a disadvantage in that it generally takes in relatively less premium than the other four indexes.


The next chart below shows the gross amounts received for monthly premiums on a % basis for the BXM Index since mid-1988. The BXM gross premiums have averaged about 1.8% per month. Note that the amounts are gross amounts and not net returns. www.cboe.com/BXM


Below is a copy of Exhibit 13 from the 2012 paper by Hewitt EnnisKnupp – “The CBOE S&P 500 BuyWrite Index (BXM) – A Review of Performance” (available at www.cboe.com/buywrite ). Note that the gross premiums (in blue) often were much higher than the net returns (in green) for the BXM Index, particularly in 2002 and 2008. The gross premiums received by the BXM Index helped the BXM Index to generate higher net returns than the S&P 500 Index in 2001, 2002, 2007, 2008, and 2011.