Schaeffer's Trading Floor Blog

Fund Managers: Now They're Cooking With Options

Analyzing the improved performance funds are seeing through short-term options strategies

by 3/21/2014 7:20 AM
Stocks quoted in this article:

An option a day keeps the underperformance versus your peer group away!

Something like that.

Options guru John Marshall of Goldman Sachs delivered a presentation at the CBOE Risk Management Conference, and he had some very interesting data as per Matt Moran on the CBOE Options Hub. Here are some of the highlights:

  • FUND FAMILIES. Five of the top 15 fund families now have funds that use options.

  • FUNDS. At least 196 funds use options, and these 196 funds had more than $480 billion in assets under management at the end of 2013.

  • STRATEGIES. The % of positions held by mutual funds in each options strategy – 64% in short calls, 22% in short puts, 8% in long puts, and 6% in long calls.

It's pretty much taken as gospel that the buy-write is the most popular options strategy. That breakdown would seem to back that up as I would guess almost all those short calls are overwrites against pre-existing longs. The put data is surprising though, as I would have guessed that funds use puts more on the long side as protection than as (presumably) naked put shorts. Then again, a naked put short is essentially identical to a buy write, but often better as far as capital usage goes. So I would imagine funds that can just go short puts will do that in lieu of buy-writes.

Here's the best takeaway of all:

  • STRONGER PERFORMANCE. Over the 5-year period ending March 4, 2014, the funds that used options had higher returns, lower volatility, and higher risk-adjusted returns than their peer funds that do not use options. (These findings were pretty remarkable in that most of the options-based funds sell options, and the stock market experienced a strong upside move over the past five years).

The lower volatility makes perfect sense. If you buy-write, you smooth out the returns. At least you should. You will lose less on a decline thanks to the premiums you take in (and presumably roll). And you will earn less on a rally as you've capped your upside. That will also clearly boost your risk-adjusted returns.

But higher absolute returns? I agree, that's counterintuitive. Remember, they're predominantly buy-writing in a market that pretty much rallied the whole time. Consider 2013, for example. The CBOE S&P 500 BuyWrite Index (BXM) is proxy for a simple buy-write strategy and it only returned half of the SPDR S&P 500 ETF Trust (SPY) returns.

I don't have a great answer, but I'll take a stab. In the general sense, selling options adds value when the implied volatility of the options you sell exceeds the realized volatility of the underlying instrument. That's been true in the past five years more often than not. Even though implied volatility is not historically high and it has trended lower, it has been overpriced versus realized volatility.

That won't do you much good if you're just sitting with a passive short options position, as a stock or index can pile low-volatility gains on top of itself. That's basically what happened in 2013, as realized volatility mostly stayed low, but the moves were all in one direction. But a more active options-selling strategy could have outperformed the market. If you sold straddles or strangles, for example, and hedged aggressively as stocks moved, you would have had a great year. You could adjust your deltas faster than the stocks were actually moving.

We don't know how aggressively the funds hedge, although I'm sure it varies from fund to fund. We do know the duration of the options. According to the study, 47% had a duration under 30 days, so they're using short-term options more than anything else. So if they're using short-term options and hedging actively, there's a good chance they found a path to outperformance.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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