Investors who wish to explore large-sized cash-settled index tools that can help manage global equity risk are taking a look at CBOE’s options on the MSCI EAFE® Index (ticker MXEA) and on the MSCI Emerging Markets Index (ticker MXEF). These index options have the potential to generate more income by receiving options premiums, and to help protect a portfolio from damaging huge drawdowns. The combined aggregate open interest for MXEA and MXEF options grew from around 3,200 contacts at the beginning of this year, to more than 21,000 contacts earlier this week.
VOLATILITY SKEW CHART FOR MXEA AND MXEF OPTIONS - DEMAND FOR PORTFOLIO PROTECTION
The volatility skew chart below for MXEF and MXEA options shows that the implied volatility for out-of-the-money (O-T-M) put options (at 80% and 90% moneyness) was much higher than the implied volatility for at-the-money options (at 100% moneyness). Risk-averse investors often are willing to pay a premium for O-T-M index options, and more money managers have been selling cash-secured index put options in recent years.
VOLATILITY RISK PREMIUM AND RICHLY PRICED INDEX OPTIONS
Professional options managers often keep a close eye on the volatility risk premium; the implied volatility for index options often has been higher than the historic volatility and the subsequent realized volatility for the related stock index. The next chart on volatility shows a comparison since June 2016 of the CBOE Emerging Markets ETF Volatility Index (VXEEM) versus the 30-trading-day historic volatility for the MSCI Emerging Markets Index (MXEF); note that the average daily closing value for the VXEEM Index was 19.4 – much higher than the average historic volatility of 12.0 for the MXEF Index.
MXEF & MXEA OPTIONS - MANAGING GLOBAL EQUITY EXPOSURE
CBOE offers options on the MSCI MXEA and MXEF indexes for investors who wish to manage global equity exposure. Key features of the global index options include —
• Efficiency with large contract size – cash-settled options on the MSCI indexes have a $100 multiplier and a notional size that is about 26 times larger than the options on the EFA and EEM ETFs.
• Simplicity – achieve broad-market exposure in one trade, as options on MSCI options offer investors tools with the potential to adjust exposure to the global markets at a fraction of the cost of buying individual stocks and ETFs
• Cash settlement – with no unwanted delivery of stocks or ETFs
• Predetermined risk for option buyers – index option purchasers risk only the premium they pay for the option. The risk is both known and limited.
• European-style exercise – which protects option sellers against assignment prior to expiration (so-called “early assignment”)
PRICE CHART SHOWS GROWTH AND VOLATILITY
The price chart on the MXEA and MXEF indexes shows tremendous growth and volatility and drawdowns over the past three decades. Options on the MXEA and MXEF indexes provide global portfolio managers with more tools to help in achieving their investment goals.
COUNTRY WEIGHTS AND GLOBAL DIVERSIFICATION WITH THE MSCI INDEXES
In recent decades the MSCI EAFE Index has been one of the most popular indexes for managing and gauging global equity markets exposure. On July 31 the MSCI EAFE Index had 926 constituent stocks.
In June 2017 MSCI, Inc. issued a heavily publicized announcement that noted (in part) –
“ … beginning in June 2018, it will include China A shares in the MSCI Emerging Markets Index and the MSCI ACWI Index. This decision has broad support from international institutional investors with whom MSCI consulted, primarily as a result of the positive impact on the accessibility of the China A market of both the Stock Connect program and the loosening by the local Chinese stock exchanges of pre-approval requirements that can restrict the creation of index-linked investment vehicles globally. Consequently, MSCI plans to add 222 China A Large Cap stocks, representing on a pro forma basis approximately 0.73% of the weight of the MSCI Emerging Markets Index at a 5% partial Inclusion Factor. … “
The MSCI Emerging Markets Index captures large- and mid-cap representation and has 843 constituent stocks at the end of last month.
For more information on managing global risk and on CBOE’s options on the MXEA and MXEF indexes, please visit www.cboe.com/MSCI.
The author thanks Daniel Romero for his assistance in the research for this blog.