Asset Allocation Rebalancing Using Short Options

Dr. Christoph Gort, Partner, SIGLO Capital Advisors and Pav Sethi, Chief Investment Officer, CEO, Gladius Investment Group, teamed up for the “Asset Allocation Rebalancing Using Short Options” session on Thursday afternoon.  In the presentation, they highlighted results from an empirical study on the use of SPX options to implement allocation shifts with market moves.  Interestingly, the genesis for the study was a conversation between SIGLO and CBOE at last year’s CBOE Risk Management Conference Europe in Portugal.  SIGLO’s recently published study found that while not a new concept, rebalancing with options can be very efficient.  With the recommended strategy, an investor would define a Strategic Asset Allocation (SAA) point, with an upper and lower boundary, and aim for constant proportion exposure.  As Dr. Gort stated, “with a rebalancing strategy, you’re effectively making an implicit correlation bet.”

Smart rebalancing using options:
– allows to capture more of the option premium
– adds value if markets exhibit price reversals
– implies counter-cyclical behavior and constant proportion SAAs

Rebalancing using options:
– systematizes the rebalancing
– improves discipline in the process
– lowers emotionally charged discussions
– is pretty simple to implement

It was discussed that asset allocation can be used as a key determinant of long-term portfolio performance.  And rebalancing in general, reduces risk and enhances risk-adjusted returns.  Two different approaches to rebalancing were presented. In physical rebalancing, an investor is buying and selling physical assets directly (sell equities, buy bonds). In options-based rebalancing, an investor accomplishes the buying and selling of physicals assets, but with the added benefit of collecting upfront cash premiums (selling options with strike prices that correspond to rebalancing triggers).

The complete study by SIGLO Capital Advisors can be viewed at:

http://www.cboe.com/Institutional/pdf/RebalancingUsingOptionsAbsoluteFinalMarch2014.pdf