PUT a cap on drawdowns

September 15, 2017 08:00 AM

An analysis of the performance of the Chicago Board Options Exchange’s (CBOE) two put writing indexes — the CBOE S&P 500 PutWrite Index (PUT) and the CBOE S&P 500 One-Week PutWrite Index (WPUT) — indicated that they provided superior risk adjusted returns to equity benchmarks. We compared the put writing indexes to the performance of traditional benchmarks, such as the S&P 500, Russell 2000, MSCI World and Citigroup 30-year Treasury indexes.

A cash-secured put-write strategy systematically sells options collateralized by risk-free investment (U.S. Treasury Bills). The CBOE PUT and WPUT Indexes are designed to track the performance of a hypothetical passive strategy that collects option premiums from at-the-money (ATM) options on S&P 500 Index, and holds a rolling money account invested in Treasury bills (see “How it works,” below). Both strategies attempt to profit from high premiums of index options. The WPUT Index, which was launched in 2015, extends the PUT strategy to weekly S&P 500 options. Option premiums are collected weekly, instead of monthly. 

During an almost 30-year period, the PUT Index outperformed the traditional indexes on a risk-adjusted basis. The annual compound return of the PUT Index is 10.13%, compared to 9.85% for the S&P 500 Index. However, the standard deviation of the PUT Index is substantially lower — 10.16% versus 15.26%. As a result, the annualized Sharpe ratio is 0.67 for the PUT Index and 0.47 for the S&P 500 (see “Long-term performance metrics,” below). 

The data history for the WPUT Index, based on weekly options, begins in January 2006. During the last 10 years, the PUT and WPUT indexes delivered similar risk-adjusted performance and both outperformed the S&P 500 Index and other benchmarks on a risk-adjusted basis (see “Improving on what works,” right). The annual compound return is 6.59% (PUT), 5.61% (WPUT) and 7.09% (S&P 500). The annualized Sharpe Ratio is 0.52 (PUT), 0.50 (WPUT) and 0.46 (S&P 500). 

Relative to the PUT and S&P 500 Indexes, during the last 10 years, the WPUT Index has a lower standard deviation, beta with respect to the market and maximum drawdown. In particular, the standard deviation is 11.51% (PUT), 9.85% (WPUT) and 15.11% (S&P 500). The maximum drawdown is -32.7% (PUT), -24.2% (WPUT) and -50.9% (S&P 500). The longest drawdown is 29, 19 and 52 months, respectively. The WPUT appears to add an extra level of downward protection (see “Drawdown data,”below). 

Success of PUT & WPUT 

The reason the PutWrite strategies have been successful has to do with the nature of implied and realized volatility (see “Why it works,” page 35). The strategy takes advantage of well-priced puts. 

From 2006 to 2015, the average annual gross premium collected for PUT is 24.1% and 39.3% for WPUT. Premiums for WPUT are smaller, but collected weekly instead of monthly, which results in higher aggregate premiums. 

Selling one-month ATM puts 12 times a year can produce significant income. From 2006 to 2015, the average monthly premium is 2.01%. Selling one-week ATM puts 52 times a year can produce even higher income, but note that transaction costs can be higher with more frequent trades. 

Since launch of Weekly S&P 500 options, their trading volume has increased dramatically. In 2015, on average it was about 340 thousand contracts per day, representing 36% of all CBOE S&P 500 options.In 2015, weekly options volume averaged about 340 thousand contracts per day, representing 36% of all CBOE S&P 500 options.   

About the Author

Oleg Bondarenko is Professor of Finance at the University of Illinois at Chicago, and he serves on the Product Development Committee of CBOE. This story is adapted from a white paper he wrote that was commissioned by CBOE.