Cboe Global Markets

Benchmark Indices Series: Hedging Downside Exposure with PPUT, CLL and CLLZ Indices

July 15, 2021

This article is part of our three-part series: “How to Utilize Cboe’s S&P 500 Index Options Benchmark Indices,” which highlights the hedging, income-generation and spread strategies investors may explore, with analysis of more than 35 years of data history of Cboe’s benchmark indices.

While several stock indices hit numerous record highs this year and many market participants are bullishly confident, risk-averse investors are implementing hedging strategies in 2021. In fact, the Cboe SKEW Index (SKEWSM) recently reached an all-time high of 170.55, which is evidence of investor demand for hedging against big losses in S&P 500 portfolios. Some analysts believe the stock market may be overvalued, as the S&P 500 Index cyclically adjusted price-to-earnings (CAPE) ratio hit 37 in June 2021, which is much higher than its long-term average of approximately 17.2. As the economy rebounds and participants navigate a changing market environment, Cboe’s benchmark indices may help investors hedge downside risk and more. 

Strategies Using S&P 500 Index Options to Hedge

With an average daily volume (in notional terms) of more than $480 billion in the first half of 2021, S&P 500® Index options (SPX®) are highly popular portfolio management tools. There are a number of strategies that enable investors to incorporate SPX options in their portfolio. The index’s protective put strategy, which involves holding a stock basket and purchasing out-of-the money (OTM) index put options, is one of the most common index option hedging strategies and helps investors hedge some downside risk. However, if the cost of frequently paying premiums for protective puts is too high, some investors use index collar strategies that involve holding a stock basket, buying OTM index put options and selling OTM index call options. The premium received from selling the index calls may help offset some or all of the cost of buying the puts. Collars may have little or no net upfront cost, but they do come with the opportunity cost of possibly losing any upside potential during a bull market.   

Hedging with Cboe’s Benchmark Indices

There are three key Cboe benchmark indices that buy SPX put options as part of a hedging strategy. In their 35-year history, these indices have had lower standard deviations and less severe drawdowns than other key benchmark indices, while potentially lessening downside risk.

  • Cboe S&P 500 5% Put Protection Index (PPUTSM) tracks the performance of a hypothetical strategy that holds a long position indexed to the S&P 500 Index and buys a monthly 5% OTM SPX put option as a hedge.
  • Cboe S&P 500 95-110 Collar Index (CLLSM) tracks the performance of a strategy that purchases stocks in the S&P 500 Index, and each month sells SPX call options at 110% of the index value, and then each quarter purchases SPX put options at 95% of the index value.
  • Cboe S&P 500 Zero-Cost Put Spread Collar Index (CLLZSM) tracks the performance of a hypothetical option trading strategy that holds a long position indexed to the S&P 500 Index; buys a 2.5% - 5% SPX put option spread on a monthly basis; and sells a monthly OTM SPX call option to cover the cost of the put spread. 

Standard Deviations and Mitigating Drawdown Losses

As illustrated below, the PPUT, CLL and CLLZ indices have had less severe maximum drawdown losses than two key stock indices and a leading commodity index.

Drawdown Losses

*Total return (pre-tax) indices

Sources: Zephyr and Cboe Global Markets

Drawdowns Over 35 Years

(June 30, 1986 – June 30, 2021)

Performance Through the COVID-19 Pandemic

During the past six quarters, as worldwide markets coped with disruptions related to the COVID-19 pandemic, the PPUT Index had the highest returns of all six comparable indices. Additionally, the CLL Index outperformed three other indices during the same timeframe.

Index Performance Since Year-End 2019

Lower Betas for Cboe’s Benchmark Indices

Relatively low betas are an important factor when it comes to analyzing which asset classes to include in a diversified portfolio. The three Cboe benchmark indices highlighted in this article had betas of less than 0.75 over their 35-year history. Additionally, the indices had higher annualized returns than the MSCI EAFE Index.

Metrics for Benchmark Indices

Sources: Zephyr and Cboe Options Institute

Standard Deviations of Key Benchmark Indices

Sources: Zephyr and Cboe Options Institute

Additional Benefits of the PPUT Index

Less Tail Risk

The PPUT Index’s strategy, which includes buying protective puts, successfully lessened left tail risk over the index’s 35-year history. The S&P 500 Index had 35 monthly declines of 6% or more, while the PPUT Index only had 18 such declines. The PPUT Index experienced fewer declines, however it also had fewer monthly gains of more than 4% and there is a cost to buying put options.

Monthly Returns of the S&P 500 Index and Cboe S&P 500 5% Put Protection Index

Higher Returns in Tumultuous Years

In 2008 and 2020, the PPUT Index’s returns were more than 10 percentage points higher than the other stock and commodity indices analyzed, which experienced large drawdowns during those years.

Annual Returns of Key Benchmark Indices

The PPUT, CLL and CLLZ indices may be a smart choice for risk-averse investors who are concerned about factors, such as high price-to-earnings (p/e) ratios for stocks and low interest rates for bonds. With more than 35 years of strong performance history, these benchmark indices are proven to be beneficial when used in hedging strategies with a goal of mitigating drawdown risk.

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Philip Markuszewski, a summer 2021 intern on the Cboe Derivatives Strategy team, contributed to this report. 

The information in this article is provided for general education and information purposes only. No statement(s) within this article should be construed as a recommendation to buy or sell a security or to provide investment advice. Supporting documentation for any claims, comparisons, statistics or other technical data in this article is available by contacting Cboe Global Markets at www.cboe.com/Contact. Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of “Characteristics and Risks of Standardized Options.” Copies are available from your broker or from The Options Clearing Corporation at 125 South Franklin Street, Suite 1200, Chicago, IL 60606 or at www.theocc.com. Past Performance is not indicative of future results. Cboe is a registered trademark of Cboe Exchange, Inc. All other trademarks and service marks are property of their respective owners. © 2021 Cboe Exchange, Inc. All Rights Reserved.