Total Return Strategies
Buy-Write Strategies
Institutional investors routinely employ standard asset allocation policies when allocating assets. These policies typically do not have a category for hedged equities, i.e. an investment approach that utilizes long equities and sells index options against those equities. These strategies are also referred to as “buy-write,” which in this context means buying the S&P 500 Index and selling the one month at or near the money call option on that index. The Chicago Board Options Exchange (CBOE) has created buy-write benchmarks including the BXM (utilizes the S&P 500 Index and at or near the money SPX Index options) and BXY, which also utilizes the S&P 500 Index, but instead sells a 2% out of the money call against the index. Rampart was the first licensee of CBOE’s BXM Index strategy. A buy-write strategy can help institutions increase the utilization of their equity assets by monetizing the volatility of those assets and creating a new income stream from selling options.
A buy-write strategy may be expected to outperform a long only portfolio in bear markets and lag in bull markets. The BXM was the first buy-write index offered to the market in 2002 and has a price history dating back to June 30, 1986. Historically, the BXM has been able to match the long-term return of the S&P 500 Index at 2/3 of its volatility (standard deviation of return). The BXY strategy, which also has a performance history back to 1986, has outperformed the S&P 500 over the historical period at a slightly higher risk level than the BXM Index, but still less than the S&P 500 Index.
An institution can employ a BXM-like approach as an alternative to the standard BXM strategy described above. Assuming that the institution’s public equity programs are highly correlated to a broad market index like the S&P 500, it is relatively easy to implement a BXM-like hedged equity program for a portion of the equity allocation. This may be done in a transparent manner, whereby the underlying managers are unaffected by the options program, by engaging an options manager to provide an options overlay against these assets.
A common adverse reaction to buy-write strategies that institutions may have is a reluctance to give up the upside potential when the underlying equity portfolio is appreciating, particularly in a strong market environment. By definition, writing calls at 100% of portfolio value limits the upside potential to the strike price of the call written. Importantly, however, strike prices are reset 12 times per year and markets do not generally go up in a single movement. Therefore, the potential opportunity cost may be acceptable for most institutions. Alternatively, the BXY strategy, as noted above, uses a 2% out of the money option.
In addition to the BXM and BXY Indexes, the CBOE has also created other buy/write benchmarks utilizing call options for indexes, including the CBOE Russell 2000 BuyWrite Index (BXRSM) and the CBOE NASDAQ-100 BuyWrite Index (BXN).
