Académique Documents
Professionnel Documents
Culture Documents
Volume 62 Number 5
2006, Goldman, Sachs & Co.
29
Figure 1. Cumulative Total Return on the BXM and S&P 500, 1 January 1990
to 31 October 2005
31 December 1989 = 100
550
S&P 500
500
450
400
BXM
350
300
250
200
150
100
50
89
91
93
95
97
99
01
03
05
Figure 2. Annual Total Return on the BXM and S&P 500, 1 January 1990 to
31 October 2005
Annual Return %
40
30
20
10
10
20
30
90
92
94
96
S&P 500
98
00
02
04
05
BXM
30
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2.
The volatility premium: the premium that captures the impact of selling options at implied
volatility instead of at the volatility realized
over the life of the option.
3. The exercise cost: the component of the call premium that reflects the market impact of executing the sale. The bidoffer spread is the basis
for this cost unless the transaction size is large
enough to move the price.
4. The trading cost: the loss in call premium as a
result of the bidask spread.
As we demonstrate later, Items 13 are the
most important contributors to performance. Discussions of covered indexselling strategies are
usually restricted, however, to Items 1 and 2: the
ability to collect a steady premium that enhances
performance and the opportunity to capture a
spread of implied volatility over realized volatility,
which has been mostly positive at the index level.
Because of the general emphasis on these two
issues, we provide more details about them before
we discuss the significance of the third important
point, exercise cost.
Figure 3. One-Month S&P 500 Call Option Premiums for Various Strikes,
1 January 1990 to 31 October 2005
Option Premium (% of spot)
5
0
89
91
93
ATM Call
95
97
2% OTM Call
99
01
03
05
5% OTM Call
September/October 2006
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31
Figure 4. S&P 500 ATM One-Month Option: Implied and Realized Volatility,
1 January 1990 to 31 October 2005
Volatility (%)
45
40
30
Implied Volatility
20
10
Realized Volatility
0
89
91
93
95
97
99
01
03
05
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Figure 5. S&P 500 ATM One-Month Option: Implied vs. Realized Volatility
Spread, 1 January 1990 to 31 October 2005
Volatility Spread (%)
15
10
10
15
89
91
93
95
97
99
01
03
05
Note: The average spread was 2.4 percentage points; the median, 2.7 percentage points.
Source: Goldman Sachs.
September/October 2006
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33
Performance Comparison
We report in this section the historical return and
risk profiles of the fixed-strike S&P 500 buy-write
strategies over the past 15 years, analyses of index
sensitivity and exercise risk, a performance attribution analysis, and a comparison of one-month and
three-month strategies.
Historical Return and Risk Profiles. The
return characteristics of the BXM and related S&P
500overwriting strategies are attractive, as Table 1
shows, over the long history of our study, but
Table 2 indicates that these strategies have had
periods when they underperformed the index. Note
that the periods of underperformance occurred in
Table 1. Annualized Performance of BXM and Fixed-Strike S&P 500 Call Overwriting, 18 January 1990
to 17 November 2005
Annualized Return
Strategy
Return vs.
S&P 500
Return
Return vs.
Initial Delta
Standard
Deviation
Tracking Error
vs. S&P 500
10th Percentile
Monthly Return
90th Percentile
Monthly Return
2.72%
5.31%
S&P 500
10.92%
14.15%
BXM
11.27
0.35%
9.10
7.78%
1.28
2.96
ATM
13.25
2.33
5.50%
8.50
8.30
1.00
3.00
2% OTM
13.42
2.50
4.50
10.43
6.11
1.85
3.68
5% OTM
12.22
1.30
2.15
12.63
3.32
2.59
5.31
Table 2.
Strategy
Return
S&P 500
1.01%
2.88
3.89%
BXM
Return vs.
S&P 500
7.06%
Return vs.
S&P 500
2.44%
ATM
5.88
6.89
22.10
5.61
13.62
3.60
2% OTM
4.36
5.37
25.59
2.12
12.87
2.85
5% OTM
2.58
3.59
26.75
0.95
10.34
0.32
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Figure 6. Distribution of Returns from the S&P 500, BXM, and Various
Fixed-Strike Strategies, 18 January 1990 to 17 November 2005
Percent of Observations
50
40
30
20
10
0
15
12
12
15
BXM
5% OTM
2% OTM
S&P 500
September/October 2006
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35
Figure 7. RiskReturn Trade-Off for Call-Selling Strategies and the S&P 500,
18 January 1990 to 17 November 2005
Annualized Return (%)
14
2% OTM
1% OTM
ATM
13
5% OTM
12
10% OTM
11
S&P 500
10
8
10
11
12
13
14
15
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25
40
S&P 500 Total Return (right axis)
20
30
15
20
10
10
5
0
10
10
20
15
30
20
25
40
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
Empirical
Betab
Months
Exercised
Delta
Betaa
S&P 500
1.00
1.00
BXM
0.56
Strategy
0.53
0.47
0.51
61%
0.34
0.66
0.68
37
0.13
0.87
0.87
12
aThe
37
of the option sale as a basis for constructing a riskequivalent S&P 500 return consisting of being long
1 of the S&P 500 and investing the delta portion
at LIBOR during the life of the option. When compared with this delta-adjusted S&P 500 return
series, the ATM strategy outperformed by 5.5 percentage points, the 2 percent OTM outperformed
by 4.5 percentage points, and the 5 percent OTM
outperformed by 2.2 percentage points over the
19902005 period (see Table 2). These are solid riskadjusted alphas. To convert this covered index
strategy into an alpha-only strategy, one could
sell the call option and buy a delta-equivalent
amount of S&P 500 futures, either based on the
initial delta or replicating the shifting delta over the
course of the month.
Performance attribution analysis. The return
decomposition for the ATM, 2 percent OTM, and 5
percent OTM call-selling strategies are given in Figure 9. The bars identify how much of the performance of these strategies in excess of the S&P 500
return (the basis points given on the tops of the bars)
was a result of the fair call premium, the volatility
premium, the exercise cost, and the trading cost.16
Consistent with prior studies, we found the
following:
15 bps
1.0
8 bps
0.5
0
0.5
1.0
1.5
2.0
2.5
ATM
Volatility Premium
2% OTM
Fair Call Premium
5% OTM
Trading Cost
Exercise Cost
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Table 4. Three-Month Covered Call Strategies vs. S&P 500, 18 January 1990
to 17 November 2005
Annualized Return
Strategy
Return
Return vs.
S&P 500
S&P 500
10.59%
BXM
11.20
ATM
10.34
0.25
5% OTM
10.48
7% OTM
10% OTM
0.61%
Tracking
Error vs.
S&P 500
10th Percentile
Quarterly Return
90th Percentile
Quarterly Return
6.45%
10.44%
8.47%
2.61
7.72
8.73
9.89
2.20
5.96
0.11
11.71
6.67
4.71
8.30
10.81
0.22
12.82
5.60
5.28
9.18
10.65
0.06
14.04
4.16
5.65
11.05
In all cases, the three-month call-selling strategies underperformed the strategies selling onemonth S&P 500 options. We attribute this result to
the missed opportunity with a three-month strategy to reset the strike price monthly in rapidly
rising markets, participate in time decay more frequently in highly volatile bear market periods, and
capitalize on a favorable implied-to-realized volatility spread with a higher frequency during the
year. In a more active overwriting strategy, we
would suggest that investors shift to writing
longer-term options when implied volatility is at
the high end of its normal range and when S&P 500
expected returns are moderate or negative.
39
2
30% Probability of Exercise
0
89
91
93
95
97
99
01
03
05
Note: The shaded lines denote the average strikes3.8 percent for the 20 percent probability of exercise
and 2.4 percent for the 30 percent probability of exercise.
Sources: Standard & Poors and Goldman Sachs.
Table 5.
Prob. of
Exercise
10%
20%
30%
40%
Average
Strike
Delta
Beta
Empirical
Beta
Months
Exercised
Annual
Standard
Deviation
5.60%
3.81
2.44
1.17
0.10
0.21
0.32
0.42
0.90
0.79
0.68
0.58
0.95
0.87
0.75
0.62
8%
25
36
50
13.80%
12.76
11.26
9.77
Annual
Tracking
Error vs.
S&P 500
1.83%
3.33
5.01
6.74
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Table 6.
Strategy
S&P 500
2% OTM
30% Prob. exercise
4% OTM
20% Prob. exercise
Average
Strike
Return
2.44%
3.81
10.40%
12.45
12.13
12.35
12.40
Return vs.
S&P 500
2.05%
1.73
1.94
2.00
Tracking Error
vs. S&P 500
10th Percentile
Monthly Return
90th Percentile
Monthly Return
14.37%
10.51
11.26
12.38
12.76
5.88%
5.01
3.69
3.33
4.36%
3.27
3.52
3.80
4.01
5.98%
3.74
4.30
4.93
5.28
September/October 2006
Conclusion
This analysis closely examined the historical return
and risk characteristics of a variety of short-term
S&P 500overwriting strategies with both fixed
and dynamic strikes. These strategies have very
favorable performance characteristics at a range of
risk levels. Because of the presence of an equity risk
premium and the goal of higher returns for equitybased strategies, we would recommend strategies
at least 2 percent out of the money or with a 30
percent or less probability of exercise. The lower
exercise frequency also reduces tracking error and
operational issues compared with an ATM strategy,
as represented by the BXM. All of the strategies
adapt to changing volatility regimes because they
sell one-month options that change in price as volatility changes. Investors who hold S&P 500 exposure as part of their investment policy and who are
looking for low-risk enhancement strategies may
wish to take a close look at the opportunities offered
by the liquid short-term index option markets.
We thank Barbara Dunn and Dmitry Novikov for their
editorial and research assistance.
This article qualifies for 1 PD credit.
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41
Figure 11. Calendar-Year Performance of Fixed-Strike OTM and DynamicStrike Call-Overwriting Strategies Compared with the S&P 500,
1 January 1990 to 31 October 2005
40
S&P 500 Total Return (right axis)
10
30
6
20
10
0
2
10
6
20
10
30
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
40
S&P 500 Total Return (right axis)
10
30
6
20
10
0
2
10
6
20
10
30
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
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12
12
Note: The ovals indicate excess returns of the strategy in stronger equity markets.
Sources: Standard & Poors and Goldman Sachs.
September/October 2006
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43
Appendix A. Calculation of
the BXM
The BXM is calculated as follows:
Rt 1,t =
St + Dt Ct
1,
St 1 Ct 1
)(
(1 + RInitiation, t ) 1,
where
Rt1,Settlement
Rt 1,Settlement =
RSettlement , Initiation =
St 1 Ct 1
SVWAP
1,
S SOQ
and
RInitiation, t =
44
St Ct
1,
SVWAP CVWAP
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Appendix B. Calculation of
Covered Call Strategy Returns
In our analysis, the index calloverwriting strategy
returns were calculated as follows:
where
St = the S&P 500 value at the close of day t
Dt = cash dividends on stocks that went ex
dividend on day t, expressed in S&P 500
index points
Ct = the average of the last bid and ask prices
of the S&P call option reported before
4:00 p.m. EST on day t
On expiration days, when the options in the strategy are rolled, the return consists of three portions:
S SOQ + Dt CSettlement
where
CSettlement = settlement price of the expiring call
CVWAP = volume-weighted average of the
prices (VWAP) of the new onemonth ATM option from 11:30
a.m. to 12:00 p.m. EST
SVWAP = VWAP level of the S&P 500 with
the same time and weights as used
in the calculation of CVWAP
1,
Rt 1,t =
St + Dt St 1 Ct 1 e Lt 1
C
+
t ,
St 1
St 1
St 1
where
St = the S&P 500 value at the close of day t
Dt = cash dividends on stocks that went ex
dividend on day t, expressed in S&P 500
index points
Ct1 = call premium (bid price) received on the
Thursday before expiration (time t 1)
Ct = call premium (ask price) paid on the
Thursday before the next expiration
(time t) to buy back the option
= investment horizon (one month or three
months)
Lt1 = continuously compounded annualized
LIBOR at time t 1 for investment horizon
For the one-month strategy, t 1 to t covers one
month, from the Thursday before expiration to the
Thursday before the next expiration; for the threemonth strategy, it covers from the Thursday before
the expiration to three months later.
For the dynamic-strike strategies for which we
assumed that the rolling of the strategy coincided
with expiration (both at the close on month-end),
the strategy returns can also be written as
Rt 1,t =
St + Dt St 1 Ct 1 e Lt 1
+
St 1
St 1
S St 1
max 0, t
,
S
t 1
that during the 199597 period, S&P 500 overwriting with one-month ATM options was quite costly.
Cumulative underperformance was 41 percentage
points for the BXM and 35 percentage points for the
ATM option. By selling the 2 percent OTM option
instead in this time period, the drag was reduced
by more than 50 percent to less than only 20
percentage points underperformance. Similar
results are visible for the worst 12-quarter periods
(Panel B). Selling three-month S&P 500 OTM calls
produced the worst relative underperformance
negative 2946 percentage pointswhich occurred
in the 199698 period.
These extreme relative returns highlight one of
the reasons this strategy may be more appealing over
the very long run (10 years): It produces multipleyear returns below the index when equity markets
are in a sustained bullish phase. Few investors, however, expect the market experience of the second half
of the 1990s to be repeated soon, which is a primary
reason overwriting has much appeal today.
Table C1. Extreme Cumulative Returns Relative to the S&P 500, 18 January 1990 to 17 September 2005
Three Years
(January to January)
Strategy
Period
36-Month Period
Excess
Return vs.
S&P 500
S&P 500
Return
Period
Excess
Return vs.
S&P 500
S&P 500
Return
34.1%
Mar 00Mar 03
26.5%
37.3%
0002
24.0%
9901
37.7
2.5
Aug 98Aug 01
41.2
12.4
0002
26.4
34.1
Aug 98Aug 01
30.4
12.4
0103
14.1
11.9
Oct 01Oct 04
16.0
8.6
9597
9597
9698
9698
41.1
34.7
16.1
8.3
117.3
117.3
110.5
110.5
Jul 94Jul 97
Jul 94Jul 97
Jul 94Jul 97
Nov 95Nov 98
54.9
51.8
27.2
9.8
120.7
120.7
120.7
104.1
Strategy
Best relative performance
BXM
5% OTM call selling
7% OTM call selling
10% OTM call selling
Worst relative performance
BXM
5% OTM call selling
7% OTM call selling
10% OTM call selling
Period
Excess
Return vs.
S&P 500
S&P 500
Return
0002
0002
0002
9901
24.0%
21.8
16.1
10.4
9597
9698
9698
9698
41.1
45.9
38.8
29.3
12-Quarter Period
Period
Excess
Return vs.
S&P 500
S&P 500
Return
34.1%
34.1
34.1
2.5
Apr 00Apr 03
Jan 00Jan 03
Jan 00Jan 03
Jan 99Jan 02
25.4%
21.8
16.1
10.4
35.6%
34.1
34.1
2.5
117.3
110.5
110.5
110.5
Jul 94Jul 97
Apr 95Apr 98
Apr 95Apr 98
Jan 96Jan 99
54.9
51.0
40.9
29.3
120.7
133.4
133.4
110.5
September/October 2006
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45
Notes
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
References
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Option Selling Strategies Can Generate Alpha Even in a Flat
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Feldman, Barry, and Dhruv Roy. 2004. Passive Options-Based
Investment Strategies: The Case of the CBOE S&P 500 BuyWrite
Index. Ibbotson Associates (28 July).
Hill, Joanne M., and Krag (Buzz) Gregory. 2002. Covered Index
Strategies: Appealing Features for Total Return or IncomeOriented Equity Investors. Goldman Sachs Equity Derivatives
Strategy (22 October).
Hill, Joanne M., and Dmitry Novikov. 2006. Covered Index
Strategies: Revisiting a Source of Enhancement for Equity Beta
Exposure. Goldman Sachs Equity Derivatives Strategy (28
February).
Hill, Joanne M., Krag (Buzz) Gregory, and Venkatesh
Balasubramanian. 2003. Capturing Returns from Index
Volatility Selling Strategies. Goldman Sachs Equity Derivatives
Strategy (27 January).
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