This column was originally published on RealMoney on June 20 at 3:26 p.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.
The Chicago Board Options Exchange is set to begin publishing the CBOE S&P 500 PutWrite Index (PUT) to create a benchmark for a portfolio that sells
index (SPX) put options as an ongoing strategy.
This would be the sister product to the CBOE's BuyWrite index (BXM), which has become the benchmark and has helped fuel the boom in broad-market covered-call funds. Remember, the risk/reward profile of a covered call is essentially the same as selling a naked put.
The main difference will be the put-write is secured against cash, while the buy-write uses the ownership of the underlying stock or security as collateral. The PUT strategy is designed to sell a sequence of one-month at-the-money S&P 500 index puts and invest cash in one- and three-month Treasury Bill rates.
The number of puts sold varies from month to month, but is limited so that the amount held in Treasury Bills can finance the maximum possible loss from final settlement of the SPX puts. In the worst-case scenario, the amount at risk for the PUT investor is limited to the amount that was invested.
Backtested data covering the past 20 years show the PUT index had an annualized return of 12.6% compared to BXM's 11.8% annualized return and the S&P 500's 12.1% return over the same time period. The PUT also had a lower beta or was less volatile than either the buy-write or underlying index.
I think this is good, in that it makes clear that covered calls and naked puts carry basically the same risk. But it is also a sign of how the growing use of derivatives to gain incremental increases in yield leads to a decrease in volatility.
This happens because the funds that dominate the markets are basically all trying to squeeze that last bit of premium out these products, while trusting that they're hedging and, therefore, have no additional risk.
Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He appreciates your feedback;
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