In recent years I have heard interest from pension fund sponsors in exploring the concept of selling both covered calls and cash-secured puts. In 2015 Cboe introduced the Cboe S&P 500 Covered Combo Index (CMBO), a benchmark index that sells S&P 500® (SPX) put options and call options, and that has more than 32 years of price history.
A paper by the consulting firm Cambridge Associates - Highlights from the Benefits of Selling Volatility – noted that --
“Over the past 20 years, a strategy of systematically selling out of the money puts and calls on the S&P 500 Index (a short strangle portfolio) would not only have soundly beaten equity returns with lower volatility, but also offered similar returns to the median hedge fund manager tracked by Cambridge Associates, albeit with slightly higher volatility …”
RETURNS AND STANDARD DEVIATIONS
The two charts below show that the CMBO Index had higher returns and lower volatility than the MSCI EAFE, S&P GSCI, and Citigroup Treasury bond indexes over a period of more than 32 years.
In answer to the question of how the CMBO Index had relatively strong returns and low volatility, the volatility risk premium may help explain some of the strong risk-adjusted performance. The paper Highlights from the Benefits of Selling Volatility also noted that -
“ … investors should take a serious look at the benefits of a fully collateralized option-selling program designed to capture the historical spread between implied volatility (e.g., the VIX) and realized volatility. There has been a persistent historical premium for implied volatility relative to realized volatility. …”
HISTOGRAM AND LESS LEFT TAIL RISK
In regard to left tail risk, the histogram shows that the S&P 500 Index had 13 monthly declines of worse than down 8%, while the CMBO had only 6 such declines.
TABLE SHOWS LOWER BETA AND HIGHEST SHARPE RATIO FOR CMBO INDEX
The table below shows that the CMBO Index had:
- Higher risk-adjusted returns (as measured by its Sharpe Ratio of 0.59) than the other six indexes in the table; and
- A beta of 0.66 (lower than the MSCI EAFE Index) and an R-Squared measure of 82.66.
Investors who are trying to enhance and diversify their portfolios often seek to find indexes with low betas and low R-Squared, and high Sharpe Ratios. One caveat to use of the Sharpe Ratio is the fact that all of the indexes have negative skewness,
BACKGROUND - DESCRIPTION OF CMBO INDEX
The Cboe S&P 500 Covered Combo Index is designed to track the performance of a hypothetical "short strangle" strategy collateralized by a portfolio holding a long position indexed to the S&P 500 Index and a money market account invested in one-month Treasury bills. 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 SPX Index position. The CMBO Index rolls on a monthly basis, typically every third Friday of the month.
LINKS TO MORE INFORMATION
The microsite for the CMBO Index is at www.cboe.com/CMBO.
For more information on dozens of CBOE benchmark indexes, please visit www.Cboe.com/benchmarks for research papers and price charts.
Information on upcoming Cboe Risk Management Conferences in Europe, Asia and the United States is at www.cboermc.com.