Constructing/Deconstructing Volatility Risk Premia Strategies

I have to include a personal note – this is the best first presentation I have ever witnessed at a CBOE Risk Management Conference.

The first session of the 32nd Annual CBOE Risk Management Conference paired up Mark Shore who is Chief Research Officer from Shore Capital Research as well as an Adjunct Instructor at DePaul University with Roni Israelov, Portfolio Manager from AQR Capital Management.  Their session was titled Constructing / Deconstructing Volatility Risk Premia Strategies.

The session started off with Shore reviewing his recent work on benchmark indexes based on Russell 2000 (RUT) Index option strategies.  The six RUT benchmark indexes that were covered in Shore’s study are

  • CBOE Russell 2000 BuyWrite Index (BXR)
  • CBOE Russell 2000 Zero-Cost Put Spread Collar Index (CLLR)
  • CBOE Russell 2000 Conditional BuyWrite Index (BXRC)
  • CBOE Russell 2000 30-Delta BuyWrite Index (BXRD)
  • CBOE Russell 2000 PutWrite Index (PUTR)
  • CBEO Russell 2000 One-Week PutWrite Index (WPTR)

The full list of all CBOE strategy benchmark indexes and a link to his study may be found at

Shore’s work is more than could be covered in his allotted time or effectively in this space.  I strongly encourage anyone interested in his work to visit CBOE’s website and download the study.  The highlights of his presentation include –

  • On an absolute and risk adjusted basis PUTR outperforms the Russell 2000
  • The standard deviations of the six RUT benchmarks covered in this study are consistently lower than that for the Russell 2000
  • He also showed a chart of the volatility risk premium for Russell 2000 options relative to realized volatility of Russell 2000 options using the CBOE Russell 2000 Volatility Index – which shows that RVX frequently overstates realized volatility
  • Another chart shown, and available in his study through the link above, notes that selling weekly RUT options consistently brings in more premium than selling monthly options since there are more opportunities to bring in premium with weekly than monthly options

Israelov’s part of the presentation offered a discussion of performance attribution for covered call strategies.  His full paper may be found in the November/December 2015 issue of the Financial Analysts Journal.  He breaks out three sources of return for a covered call –

  • Selling Call Introduces Equity Timing Exposure
  • Selling Call Introduces Short Volatility Exposure
  • Selling Call Reduces Passive Equity Exposure

Highlights of each sort of risk and return for covered calls –

Equity Timing Exposure

There is virtually no extra return contribution, but equity timing exposure increases the risk of selling calls.  He notes that 26% of the risk of a covered call strategy relates to equity timing exposure.

Short Volatility Exposure

Is the most consistent of the three exposures with respect to returns and also is a very minor contributor to risk.  Israelov notes that this is really where the alpha, or excess return, is coming from with covered call strategies.

Passive Equity Exposure

With an at the money call option, the passive equity return is reduced to about 0.50 beta.  This is the most volatile of the three exposure and involves the price rise that is capped, but also has downside exposure.

After noting that Passive Equity Exposure increases risk but does not contribute much alpha, he introduces what he calls the Risk Managed Covered Call which involves consistent re-hedging.  The result is lower volatility and superior returns when compared to the CBOE S&P 500 BuyWrite Index (BXM).  He also noted that downside Beta, which is a concern with BXM is mitigated using the Risk-Managed Covered Call strategy.  He finally showed that the risk managed strategy has lower drawdowns than BXM.

The paper discussed is available at