January 12, 2016 - Equity Options
Is selling market index call options to finance, at least partly, buying crash protection in the form of put options a shrewd tactic? In their December 2016 paper entitled “Risk and Return of Equity Index Collars”, Roni Israelov and Matthew Klein investigate the performance of such equity index collars by decomposing their returns into equity risk premium and volatility risk premium components. They treat the CBOE S&P 500 95-110 Collar Index (CLL) that buys three-month put options about 5% out-of-the-money and sells one-month call options about 10% out-of-the-money as representative of equity index collars. They consider four alternatives to CLL (normalized via leverage to provide the same compound return as CLL):
- Reduce equity exposure with cash.
- Buy put options per CBOE S&P 500 5% Put Protection Index (PPUT).
- Sell covered calls per CBOE S&P 500 BuyWrite Index (BXM).
- Sell covered calls and adjust the equity index position to maintain a constant equity exposure (hedged covered calls).
Using monthly returns for the S&P 500 Index, CLL, PPUT and BXM as available (starting July 1986 or March 1996) through December 2014, they find that: Keep Reading