With U.S. stock market indexes recently hitting all-time highs, there is quite a bit investor uncertainty about the markets and there is high demand for protection from large market declines. One metric providing evidence of this high demand is the CBOE SKEW Index (SKEW). In the 27 years from 1990 through 2016, the average daily level for the SKEW Index was 118.4, and the average level of SKEW never topped 130 in any of those 27 years. In the year 2017 (through February 7) the average daily level of the SKEW Index was a relatively high 131.7, which could indicate increased relative demand for use of out-of-the-money SPX put options for portfolio protection.
Histograms and Profit-and-Loss Diagrams
Tools that can be helpful to investors who are attempting to assess the utility of various options-based strategies include (1) histograms with analyses of monthly returns for several CBOE benchmark indexes, and (2) profit-and-loss diagrams. CBOE provides more than 30 strategy benchmark indexes that can help investors compare and contrast the hypothetical performance of different options strategies in different market scenarios. www.cboe.com/benchmarks.
Below are 15 histograms that compare past performance of CBOE benchmark indexes and related stock indexes. These histograms can provide valuable information to investors who have high aversion to losses or a desire for more upside potential.
As shown in the 15 histograms below, the “best” big-loss-avoidance past performance by an index -- in terms of avoiding monthly losses of 6% or more – was by the CBOE S&P 500 Iron Butterfly Index (BFLY). In the 30+ year period from July 1986 through January 2017, the number of months that indexes had loss of worse than 6% were –
- 2 months for the CBOE S&P 500 Iron Butterfly Index (BFLY)
- 6 months for the CBOE S&P 500 95-110 Collar Index (CLL)
- 12 months for the CBOE S&P 500 BuyWrite Index (BXM) (which writes at-the-money SPX options)
- 19 months for the CBOE S&P 500 30-Delta BuyWrite Index (BXMD) (which writes out-of-the-money SPX options)
- 26 months for the S&P 500 Index
The CBOE S&P 500 Iron Butterfly Index (BFLY) tracks the performance of a hypothetical option trading strategy that 1) sells a rolling monthly at-the-money (ATM) S&P 500 Index (SPX) put and call option; 2) buys a rolling monthly 5% out-of-the-money (OTM) SPX put and call option to reduce risk; and 3) holds a money market account invested in one-month Treasury bills, which is rebalanced on the option roll day and is designed to limit the downside return of the index
Compare the CBOE BFLY Index histogram above with the iron butterfly profit-and-loss diagram below. It appears that certain iron butterfly strategies could have the potential to lessen the probability of huge upside and downside moves.
The CBOE S&P 500 95-110 Collar Index (CLL) purchases stocks in the S&P 500 index, and each month sells SPX call options at 110% of the index value, and each quarter purchases SPX put options at 95% of the index value.
The CBOE S&P 500 Risk Reversal Index (RXM) is a benchmark index designed to track the performance of a hypothetical risk reversal strategy that: (1) buys a rolling out-of-the-money (delta ≈ 0.25) monthly SPX Call option; (2) sells a rolling out-of-the-money (delta ≈ - 0.25) monthly SPX Put option; and (3) holds a rolling money market account invested in one-month Treasury bills to cover the liability from the short SPX Put option position.
The CBOE S&P 500 Zero-Cost Put Spread Collar Index (CLLZ) tracks the performance of a hypothetical option trading 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 cover the cost of the put spread.
The CBOE S&P 500 Iron Condor Index (CNDR) tracks the performance of a hypothetical option trading strategy that 1) sells a rolling monthly out-of-the-money (OTM) S&P 500 Index (SPX) put option (delta ≈ - 0.2) and a rolling monthly out-of-the-money (OTM) SPX call option (delta ≈ 0.2); 2) buys a rolling monthly OTM SPX put option (delta ≈ - 0.05) and a rolling monthly OTM SPX call option (delta ≈ 0.05) to reduce risk; and 3) holds a money market account invested in one-month Treasury bills, which is rebalanced on option roll days and is designed to limit the downside return of the index.
The CBOE VIX Tail Hedge Index (VXTH) buys and holds S&P 500 stocks, and also often buys 30-delta call options on the CBOE Volatility Index® (VIX®).
With the at-the-money (A-T-M) buy-write strategy, an investor often takes in more options premium, but has no participation in stocks’ upside moves, when compared with the out-of-the-money (O-T-M) buywrite strategy. Compare right and left tails for the BXM and BXR indexes above, versus the BXMD and BXRD indexes below.
Representatives of Wilshire and of Fund Evaluation Group will discuss CBOE Benchmark indexes and downside risk at the 33rd Annual CBOE Risk Management Conference (RMC) next month. www.cboermc.com.
For additional information about the CBOE benchmark indexes and related white papers on portfolio management, please visit www.cboe.com/benchmarks.