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CBOE Risk Management Conference Dublin - September 2014
SIGLO Capital Advisors AG
Rebalancing Using Options
SIGLO Capital Advisors AG | Birmensdorferstrasse 140 | CH-8003 Zurich | Switzerland Phone: +41 44 576 40 76 | Fax: +41 44 576 40 73 | [email protected] | www.siglo.ch
Agenda
• Blends / Assemblage
• Option-writing
• Rebalancing
• Strategic asset allocation of Swiss institutional investors
• What we did in our paper
• We found a fine blend but there might be even better ones
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Blends – or as the Swiss say “Assemblage”
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Assembling and blending existing pieces and smart ideas can lead to great results Top French wines “assemble” up to 20 grapes Picasso and others “assembled” pictures Steve Jobs “assembled” technological ideas at Apple
Option-writing – Popular research branches and topics I
Option pricing and valuation • In the 60ies Ed Thorp trades options in a very smart way and discovers convertible arbitrage • The academics Fischer Black & Myron Scholes publish their thesis on option pricing in 1973 • Sheldon Natenberg has been describing ways how to trade volatility in practice for decades VIX • Robert Whaley and CBOE create the first volatility index in 1992 Risk premium discussion • Antti Ilmanen describes that selling volatility has on average generated positive returns • Nassim Taleb counters with Black Swans and argues to be long volatility
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Option-writing – Popular research branches and topics II
Other uses of options in the portfolio context: • Hedging exposures or bets • Generate alpha • Find uncorrelated returns
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The implied volatility of stock markets has often been higher than the realized volatility
Rebalancing I
The Talmud advices to invest a third in each land, business and reserves Claude Shannon taught to rebalance on the stock market at MIT in the 60ies Benoit Mandelbrot’s fractals Stock prices and PE ratios tend to mean-revert over the last centuries, decades and also short-term
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Rebalancing II
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Strategic asset allocation of Swiss pension funds
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0.00%$
10.00%$
20.00%$
30.00%$
40.00%$
50.00%$
60.00%$
70.00%$
80.00%$
90.00%$
100.00%$
2004$ 2005$ 2006$ 2007$ 2008$ 2009$ 2010$ 2011$ 2012$
Average'Strategic'Asset'Alloca/on'of'Swiss'Pension'Funds'
Liquidity$and$Cash$ Bonds$ Equi=es$ Real$Estate$ All$Others$
Equi%es 30% 100%
Fixed Income 50% 100%
Real Estate 20% 100%
Institutional investors usually define a strategic asset allocation (SAA) A SAA does not only contain percentage points for allocations but also lower and upper boundaries (constant proportion SAA) Boundaries are used to keep exposures constant over time and his implies rebalancing
Lower boundary Point Upper boundary 27% 30% 33%
Why we believe our assemblage to be interesting I
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Equi%es 26% 27% 28% 30% 32% 33% 34%
Lower boundary SAA Point Upper boundary
Sell puts with strike at boundary 3% in SAA equals 15% OTM Buy equities at the price your SAA asks you to buy anyway
Sell calls with strike at boundary 3% in SAA equals 15% OTM Sell equities at the price your SAA asks you to sell anyway
If equity allocations fall more than 10% in the SAA, investors buy equities and rebalance the entire portfolio back to the original SAA
If equity allocations increase more than 10% in the SAA, investors sell equities and rebalance the entire portfolio back to the original SAA
Investors who aim for constant proportion exposure in the SAA get what they want anyway… …plus a potential premium from writing options!
Capture the option premium if prices do not move beyond the boundaries
Why we believe our assemblage to be interesting II
Systematize the rebalancing Avoid discretionary decisions under stress Avoid behavioral biases by forcing some discipline onto the rebalancing process Simple and straight implementation possible
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Methodology and Data
• Base case SAA: 30% Equities 50% Government Bonds 20% Real Estate
• Asset Class ProxiesS&P 500 TR Index Citigroup WGBI hedged in USD WUPIXF hedged in USD
• OptionsTraditional S&P 500 index options traded on CBOE (no LEAPs)Always trade on bids and take full spread crossingconsidering only non-zero bid options take option trading fees into accountWe always sold front-month options with “close-enough” strike and maturityOptions are fully collateralized by short-term US-Treasuries
• Assumption of using part of the bond allocation as collateral / margin
• Assumption of having observable prices for all asset classes at hand to rebalance entire portfolio and ability to trade all asset classes accordingly
• Observation Period is from January 1997 to December 2013
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Results and benchmark comparison I
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Our base case: Sell permanently 1-months call and put options with strike equal to the SAA rebalancing boundaries 3 Benchmarks to gauge the base case performance: • Trigger-based (D): Rebalance instantly if boundaries are hit (maybe only possible with futures)
• Calendar-based (Q): Rebalance at the end of every quarter if boundaries are hit
• Buy-and-hold: Lean back and pray for market efficiency
Ann. return Ann. volatility Return / Risk Max drawdown
Base Case 6.83% 5.57% 1.23 16.27%
Trigger-based (D) 6.85% 5.51% 1.24 15.99%
Calendar-based (Q) 6.76% 5.44% 1.24 15.65%
Buy-and-hold 6.43% 5.54% 1.16 15.18%
Results and benchmark comparison II
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Ann. return Ann. volatility Return / Risk Max drawdown
Rulebased Implementation 6.93% 5.51% 1.26 15.27%
Base Case 6.83% 5.57% 1.23 16.27%
Trigger-based (D) 6.85% 5.51% 1.24 15.99%
Calendar-based (Q) 6.76% 5.44% 1.24 15.65% Buy-and-hold 6.43% 5.54% 1.16 15.18%
Can we do a little better? Yes, we can with a slightly smarter rulebased implementation • Use multiple call and put options with different strike levels to smoothen the rebalancing
• Use 3-months options instead of 1-months There are certainly many more ways to improve, like steepness of the curve or….
Sensitivity analyses
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• It works with SPX and MSCI World Index as equity proxies Other equity proxies
• It works great with 50-50 bond equity portfolios • It works great with fixed real estate allocation Other SAA
• It works better using multiple options with different strikes Multiple strike levels
• VIX level is a weak indicator but VXV-VIX is helpful Watch the shape of the curve
• Only write options if we are not too close to boundary Distance to SAA boundaries
• Writing 3-months options performs better than 1-month Maturity
• Wider or narrower boundaries work but less convincingly Other SAA boundaries
• Options are fully collateralized by short-term US-Treasuries Collateral
We found a fine blend...
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rebalancing using options… …systematizes the rebalancing …improves discipline in the process …lowers emotionally charged discussions …is pretty simple to implement Investors who aim for constant proportion exposure in the SAA get what they want anyway…
…plus a potential premium from writing options!
Smart rebalancing using options…. …allows to capture more of the option premium …adds value if markets exhibit price reversals … implies counter-cyclical behavior and constant proportion SAAs that make sense for investors
…but there might be even better flavors to be assembled
• Use multiple asset class underlyings for option-writing
• Apply more granularity across underlyings
• Enhance returns by exploiting the shape and the dynamics of the volatility curve
• Use options to express tactical views
• Download the full paper on CBOE’s websitehttp://www.cboe.com/Institutional/reports.aspx
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Your humble authors – another assemblage
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Emanuel Burgener!"Head of Quantitative Research"ecamos Investment AG""[email protected]""www.ecamos.ch"
Dr. Christoph Gort !"Partner"SIGLO Capital Advisors AG""[email protected]""www.siglo.ch"
SIGLO at a glance
SIGLO Capital Advisors AG
• is a Zurich based investment advisor • assists its clients with the implementation of their investment strategy and supports them in
the selection and the proactive monitoring of individually suitable investment solutions
• offers tailormade advisory for an optimal investment management, choice of policy and performance appraisal for entire portfolios or particular allocations
• is 100% owned by the three partners and fully independent. SIGLO does not have either in-
house products or relationships with any financial institution • supports clients by providing concrete and targeted analyses and investment advice
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Disclaimer
The information contained in this presentation is provided for information purposes only. It should not be construed as investment advice and is subject to change without notice. All statements and expressions are the opinion of SIGLO Capital Advisors AG and are not an offer or solicitation to buy any financial services or financial instruments. Investors should bear in mind that investing in securities, mutual funds, hedge funds, private equity funds or similar investment products as well as investing in foreign currencies is highly speculative and carries a high degree of risk. Any investment can result in the total loss of assets. Past performance is no guarantee of future performance and the value of investments can fall as well as rise, especially over the short term. SIGLO Capital Advisors AG does not warrant or make any representation as to the accuracy or completeness of any information expressed in this presentation. SIGLO Capital Advisors AG does not accept any responsibility for any loss which may arise from the use of the information in this presentation. All information in this presentation is the property SIGLO Capital Advisors AG and cannot be reproduced for any business purpose without the express prior written consent of SIGLO Capital Advisors AG .
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