New Studies on Funds’ Use of Options for Managing Volatility

Contributed by: Chetan Shah, CFA

IAIP was pleased to conduct a speaker session on Funds’ use of Options in Mumbai and Kolkata on September 16^th and 19^th. And what a better person than Mathew Moran, VP, CBOE (Chicago Board Options Exchange). Matt shared the brief chronology of when various options were introduced and the insights from various studies conducted on the use of options by funds in managing volatility and results thereon. The event was well received by the members.

According to Goldman Sachs papers on mutual fund use of options in 2012 & 2014 at least 196 funds having size of $460bn used options at the end of 2013. The most popular strategy being short or write call (64%), short/write Put (22%), long/buy puts (8%) and long/buy calls (6%). About 47% of short positions had a maturity of 30 days or less while about 40% of long options positions had a maturity of 30 days or less. Over the 5-year ending March 4, 2014, the funds that used options had higher returns, lower volatility, and higher risk-adjusted returns than their peer funds that did not use options.

A study in January 2015 by Keith Black, CFA and Edward Szado, CFA show how the number of funds using options have increased from 10 in 2000 to 119 by end 2014. It provides various statistics right from the annual & average monthly returns, standard deviations, maximum drawdowns, Skew, Kurtosis, Sharpe ratio, Jensen’s Alpha etc. Not only is the returns of PUT & BXY higher than S&P500, the standard deviation and maximum drawdowns in 2008 too are far better (kindly refer to the presentation). PUT stands for CBOE S&P 500 PutWrite Index and involves strategy of buying treasury bills and selling cash-secured put options on the S&P500 index. BXY, CBOE S&P500 2% OTM BuyWrite Index, involves purchasing stocks in the S&P500 index and selling each month index options 2% out-of-the-money.

A Russell Investments Study on Capturing the Volatility Premium through Call Overwriting (2012) illustrates how call overwriting can provide income generation – more by writing short tenure options than longer dated as well as selling ATM options than OTM –  and a cushioning effect on downside. This outcome is achieved by selling insurance to the marketplace in the form of call options and capturing the volatility risk premium embedded in these options. It goes without saying that call writing strategies will underperform long-only equity funds in bullish or very bullish equity markets.

• CGS

PS: Some of the articles by Matt can be read on CBOE website; the most recent being: A Dozen Positive Developments in 2015 for Investors in Options http://www.cboeoptionshub.com/2015/05/05/a-dozen-positive-developments-in-2015-for-investors-in-options/

Matt’s presentation could also be accessed at India page of CFA Society.