March 2015

ASSOCIATION COLUMN: Performance of options-based funds

Gary DelanyWhen you think of funds, you do not necessarily think of options as well, but in the US the two instruments overlap. A new study – Highlights of Performance Analysis of Options-Based Equity Mutual Funds, CEFs, and ETFs – looks at US investment companies regulated by the Securities and Exchange Commission that focus on the use of exchange-listed options for portfolio management. The study was commissioned by CBOE on behalf of the Institute for Global Asset and Risk Management. Its authors are Keith Black of the US Chartered Alternative Investment Analyst Association and Edward Szado, assistant professor of finance at Providence College, Rhode Island.  The study found that the number of options-based funds grew from 10 in 2000 to 119 in 2014, and includes for the first time a publicly available list of names and ticker symbols for those options-based funds.   The study analysed the equal-weighted performance of a subset of the options-based funds – that is, those that focus on the use of US stock index options and/or equity options – and found during the 15-year period 2000-2014 that these funds had: 
  • similar returns as the S&P 500 and higher returns than the MSCI EAFE Index;
  • higher lower volatility and a lower maximum drawdown than the S&P 500 and S&P GSCI indexes. 
The average annual distribution yield for options-based funds was more than 5% in each of the past nine years. While this distribution yield does not guarantee a positive performance by the funds, the distribution yield feature may appeal to investors who are discouraged by low interest rates.   The study also found that the CBOE S&P 500 PutWrite Index (PUT) and the CBOE S&P 500 2% OTM BuyWrite Index (BXY) both produced higher returns and lower volatility than the S&P 500 and S&P GSCI indexes during the period from mid-1988 to the end of 2014. A key source of strong returns for index-option-writing strategies has been the fact that index options usually have been richly priced.  Institutional investors are interested in the notional capacity of markets in financial instruments. The estimates for notional value of average daily volume in SPX options rose from $13 billion (€11.4 billion) in 2000 to more than $170 billion in 2014. Some investors do use a delta-weighting adjustment to develop a more conservative estimate of notional value of options trading, and the bid-offer spreads for many instruments can widen in time of high anxiety.     This is an interesting and thorough study, full of detail that illustrates the versatility of options as hedging or positioning instruments.   As an aside to those not aware of the fact, the US equity option market transacted more than 4.2 billion contracts in 2014 and has expanded dramatically since its origins in the 1970s, as the usage of options by investors and risk managers of all sizes has expanded, complemented by a competitive and innovative market. Education plays an important part in the development and proper usage of any financial instrument. The Options Industry Council (OIC) has been doing this since 1992. All of its educational material is entirely free and can be accessed at 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 the Options Clearing Corporation at Gary Delany is European director at the Options Industry Council (OIC) ©2015 funds europe

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