In session 3 of the third and final day of the first Annual CBOE Risk Management Conference Europe, Jerome Dominge, Head of Institutional Product Engineering Paris, BNP Paribas, discussed “Systematic Use of Options in Portfolio Management.”
First, Mr. Domingue said that options are interesting for systematic strategies because of their non-linear payout, which means that, for a small payment, practical profit possibility is very large. Second, he says that options, historically, have been statistically over priced.
Step one is defining the strategy. Are you going to buy or sell an option? What strike and what maturity are you going to choose? Second, you must choose the frequency at which you going to roll the position. The systematic purchase of puts against a long equity portfolio accomplishes two objectives. It limits risk on the downside and keeps the upside exposure intact.
By choosing a “distance to strike” (percentage out of the money) and by adjusting the put position every day, time decay is reduced and the protection is not reduced. Another benefit is that, over time, the average cost of the strategy approaches the average level of volatility. This lowers the strategy’s cost during times of declining volatility, typically when the market is rising. Although it tends to increase the cost during periods of rising volatility, typically, when the market is falling, the increased length of protection (by maintaining the average time to option maturity) is generally beneficial.
Mr. Domingue and his team design protection strategies for clients that target the client’s cost and maximum risk objectives. Put positions are adjusted daily. This means that, every day, a new portion of the full desired put protection is purchased at the new desired maturity and strike price and a similar portion of the existing position is sold. The net effect is that the average put strike is closer to the desired distance out of the money than a buy-and-hold put protection strategy. Also, the desired maturity is more closely maintained than a buy-and-hold protection strategy.
Mr. Domingue also discussed the systematic selling of covered calls, known as the “dynamic covered call strategy.” The short call position is adjusted daily in a similar manner to the put protection strategy described above. This is a “positive beta” strategy, but has limited upside.
The final presentation was "Analyzing and Forecasting Volatility"
Moderator: Chris Limbach, Advisor to the CEO, PGGM Investments
Andrew Harmstone, Portfolio Manager, Morgan Stanley Investment Management
Yoshiki Obayashi, Founder, Applied Academics, LLC
Matt Moran from the CBOE covered this talk.
The main topics that were covered in this session were:
– Fixed and dynamic benchmarks for expected returns and expected variances
– What role should subjective analysis play in determining volatility regimes? – Equity volatility vs interest rate swap volatility; empirical behavior of volatility surfaces
– Investment implications for different portfolios
A new index was covered at this session, the CBOE Interest Rate Swap Volatility Index ("CBOE SRVXSM Index") www.cboe.com/SRVX the first standardized volatility measure in the interest rate swap market, or indeed in the fixed-income market.
SRVX is designed to standardize and simplify trading in the interest rate swap market, much as the CBOE Volatility Index® (VIX®) does in the equity market. The interest rate swap market is the largest over-the-counter derivatives market, with notional amounts in the trillions. Matt Moran
This concluded the first CBOE Risk Management Conference Europe. There was great turnout – over 150 attendees. Lots of positive feedback from European customers and presenters was heard.
And we liked your comments as well. We will keep you informed about the location and date for the next Risk Management Conference. If you have any questions about this conference, send in a comment and we will get back to you.
CBOE Social Media Team