While much of this month’s bracketology focus is on basketball tournaments, the chart below shows investment returns for eight benchmark indexes since mid-1986. The chart includes four benchmark indexes (introduced in 2015) that invest in S&P 500® (SPX) options. In the chart the top two indexes in terms of annualized returns were the CBOE S&P 500 30-Delta BuyWrite Index (BXMD) and the CBOE S&P 500 Covered Combo Index (CMBO).
DECCRIPTIONS FOR FOUR BENCHMARK INDEXES THAT INVEST IN SPX OPTIONS
- BXMD – CBOE S&P 500 30-Delta BuyWrite Index is designed to track the performance of a hypothetical covered call strategy that holds a long position indexed to the S&P 500 Index and sells a monthly out-of-the-money (OTM) S&P 500 Index (SPX) call option. The call option written is the strike nearest to the 30 Delta at 10:00 a.m. CT on the Roll Date.
- CMBO – CBOE S&P 500 Covered Combo Index – tracks a short strangle strategy collateralized by a portfolio holding a long position indexed to the S&P 500 Index and a fixed income account. The CMBO Index sells a monthly at-the-money (ATM) S&P 500 Index (SPX) put option and a monthly 2% out-of-the-money (OTM) SPX call option. The short SPX put position is collateralized by a money market account invested in one-month Treasury bills and the 2% OTM SPX call is collateralized by the long S&P 500 Index position.
- CNDR – CBOE S&P 500 Iron Condor Index – tracks the performance of a hypothetical option trading strategy that 1) sells a rolling monthly out-of-the-money (OTM) S&P 500 Index (SPX) put option (delta ≈ – 0.2) and a rolling monthly out-of-the-money (OTM) SPX call option (delta ≈ 0.2); 2) buys a rolling monthly OTM SPX put option (delta ≈ – 0.05) and a rolling monthly OTM SPX call option (delta ≈ 0.05) to reduce risk; and 3) holds a money market account invested in one-month Treasury bills, which is rebalanced on option roll days and is designed to limit the downside return of the index.
- PPUT – CBOE S&P 500 5% Put Protection Index – strategy that holds a long position indexed to the S&P 500 Index and buys a monthly 5% out-of-the-money (OTM) S&P 500 Index (SPX) put option as a hedge.
SOURCE OF SUPERIOR RETURNS – VOLATILITY RISK PREMIUM
When viewing the chart above, one might ask – why were the annualized returns higher for the BXMD and CMBO indexes than for the CNDR and PPUT indexes (all four indexes take SPX options positions)? A key factor is the fact that in most years since 1986, the SPX options have been richly priced because implied volatility usually was higher than realized volatility – there was a volatility risk premium that often rewarded investors who were sellers (rather than buyers) of index options over the long term with higher returns. On the other hand, investors who wish to lessen their left tail risk still could explore the PPUT and CNDR indexes (and the histograms in the Black & Szado study below) for past benchmark index performance to see if buyers of protective put options could lessen left tail risk.
To learn more about benchmark indexes and return, risk, and the volatility risk premium, please see these research papers –
- Black, Keith, and Edward Szado. Performance Analysis of CBOE S&P 500 Options-Selling Indices. (2016).
- Bondarenko, Oleg. An Analysis of Index Option Writing with Monthly and Weekly Rollover. (2016).
- Asset Consulting Group. An Analysis of Index Option Writing for Liquid Enhanced Risk-Adjusted Returns (2012).
- Cambridge Associates. Highlights from the Benefits of Selling Volatility (2011).
Links to more information on the benchmark indexes and papers above are at www.cboe.com/benchmarks.