Trading in Style (Russell 1000® Index Options)

Russell 1000® Growth & Value Index Options

The CBOE recently launched options on the followed Russell 1000®, Growth, & Value Indexes.

  • The Russell 1000 (Ticker: RUI) measures the performance of the large-cap. segment of the U.S. equity market.
  • The Russell 1000 Growth Index (Ticker: RLG) measures the performance of Russell 1000 Index companies that carry a higher price-to-book ratios and forecasted growth values.
  • The Russell 1000 Value Index (Ticker: RLV) measures the performance of Russell 1000 Index companies with a lower price-to-book ratio and lower expected growth.

Performance Differences – Russell 1000 Growth vs. Value Index:

Equity markets trade through cycles of high and slow growth as evidenced by leadership changes.  The performance of the style indexes, Russell 1000 Growth & Value experienced dramatic differences in returns as seen in years 2000, 2004, 2006, 2007, & 2009.rr1

 

Changing Leadership

Over an extended period, the Russell 1000 Value outperformed Russell 1000 Growth Index.  However, within the past 5 years the cumulative returns of Russell 1000 Growth is higher than that of the Value Index.
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Russell 1000 Growth & Value Cash-Settled Index Options:
Altering the weightings between the equities benchmarked to the Russell 1000 Growth & Value Indexes can improve the cumulative return rather than simply holding a large-cap. portfolio benchmarked to the Russell 1000 Index.  Portfolio tilting is widely used to improve risk adjusted returns. As seen below, adjusting the asset weightings during the same time period, a tilt towards (70% Russell 1000 Growth Index and 30% Russell 1000 Value Index) improved the cumulative return relative to the Russell 1000 Index by over 1.63%. rr3

Tilted portfolios constructed to achieve higher adjusted returns will require occasional rebalancing when the weightings become misaligned.  Rebalancing can be accomplished in a variety of ways including the use of cash-settled index options.

Options on the Russell 1000 Growth (RLG) and Value (RLV) Index Options are an effective tool for fine tuning asset weightings by writing a call or put when the underlying assets approach the outer bands of the targeted weightings.  To illustrate, if a market rally causes the underlying Growth position to rise above 73% which is above the targeted 70% level.  Writing call options on Russell 1000 Growth Index (RLG) using a 3% notional value can effectively realign weighting to the proper level.  Alternatively, when Growth reaches 67% which is below the targeted level writing put options on the Russell 1000 Growth Index will also help realign positons to the proper level.

Benefits:

Russell 1000 Growth & Value Index options offer several benefits:

  • Large Size Notional Value – lower commissions
  • European Exercise – removes the risk of early assignments
  • 60/40 Tax treatment – Under section 1256 of the Tax Code the profit & loss on trading this option are entitled a tax rate equal to 60% long-term and 40% short term.

For further information on the Russell 1000 Family cash-Settled Index Options please visit:

Russell 1000 Index – www.cboe.com/RUI
Russell 1000 Growth Index – www.cboe.com/RLG
Russell 1000 Value Index – www.cboe.com/RLV

Post written by Rick Rosenthal, CBOE Business Development