Seven years ago several major stock indexes and commodity indexes suffered drawdowns of more than 50%, and since then there has been increased investor interest in managing tail risks.
On Wednesday, September 30, in Geneva, Switzerland at the Fourth Annual CBOE Risk Management Conference (RMC) Europe, two experts – (1) Julien Halfon, Principal - Financial Strategy Group, Mercer, and (2) Jean-Francois Bacmann, Portfolio Manager and Head of Volatility Strategies, Man AHL—delivered presentations on -
- Managing Tail Risks
- Who should hedge tail risks and is now the time?
- Understanding equity risk management needs for different institutional investors
- Past performance of various alternatives: de-risking, diversifying and hedging
- Case studies on the design and implementation of active and systematic approaches
Julien Halfon explored the pros and cons of using a number of strategies and tools, including low-volatility equities, convertible bonds, corporate bonds, Treasury bonds, structured equities, and tail risk funds, to manage tail risk.
Jean-Francois Bacmann noted that there is a large variety of tail events, hedge funds and tail events are affected by tail events, volatility offers the best hedging ability, one can look at VXV Index for 3-month implied volatility, one can look at active versus passive solutions for tail risk challenges. Mr. Bacmann noted that there has been good liquidity and transparency (but less convexity when compared to variance products) for index options, VIX futures, and VIX options.
BENCHMARK INDEXES THAT USE VIX OPTIONS OR FUTURES
The line chart below shows the changes since March 2006 for “traditional” benchmark indexes versus two indexes that use VIX options or futures -
The CBOE VIX Tail Hedge Index (VXTH) buys and holds S&P 500 stocks, and also often buys 30-delta call options on the VIX Index. In the chart below the VXTH had a 100% rise, a higher rise than the other four indexes in the chart, and the VXTH Index had relatively low volatility. In August 2015 the VXTH Index rose 0.8% and the S&P 500 Index (TR) fell 6%. www.cboe.com/VXTH.
The S&P 500 VIX Mid-term Futures Index offers exposure to a daily rolling long position in the fourth, fifth, sixth and seventh month VIX futures contracts, and reflects the implied volatility of the S&P 500 at various points along the volatility forward curve. In the chart below the S&P 500 VIX Mid-term Futures Index rose about 200% during the financial crisis seven years ago, but it has fallen precipitously since 2009 because of contango and a drop in the VIX® Index. In August 2015 the S&P 500 VIX Mid-term Futures Index rose 27.3% and the S&P 500 Index (TR) fell 6%.
HISTOGRAMS FOR BENCHMARK INDEXES THAT USE SPX OPTIONS
Below are two histograms that cover monthly returns for these indexes -
The CBOE S&P 500 Zero-Cost Put Spread Collar Index (CLLZ) is designed to track the performance of a low volatility strategy that 1) holds a long position indexed to the S&P 500 Index; 2) on a monthly basis buys a 2.5% - 5% S&P 500 Index (SPX) put option spread; and 3) sells a monthly out-of-the-money (OTM) SPX call option to fully cover the cost of the put spread. In the CLLZ histogram chart below the total number of months in which there were declines of worse that 6% were -- 13 months for the CLLZ Index and 24 months for the S&P 500 index. www.cboe.com/CLLZ
The CBOE S&P 500 30-Delta BuyWrite Index (BXMD) is designed to track the performance of a yield-enhancement 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. The BXMD Index rolls on a monthly basis, typically every third Friday of the month. In the BXMD histogram chart below the total number of months in which there were declines of worse that 6% were -- 19 months for the BXMD Index and 24 months for the S&P 500 index. The BXMD had more big-move months (both up and down) than the CLLZ Index. www.cboe.com/BXMD