MarketsMuse Strike Price curators are always looking for smart perspectives on how to bring more asset managers and institutional investors to better understand and embrace the use of options in a responsible manner. According to Todd Hawthorne, lead portfolio manager of Boston Partners, volatility [which some immediately and sometimes, misguidedly associate with the CBOE VIX Index], has created a new asset class for institutional and retail investors, and like all other asset classes, there are opportunities to harvest returns. In this case, the tools to implement volatility strategies are found via the use of options contracts.
In a recent submission to Pensions & Investments, Hawthorne writes, “These volatility strategies, when viewed as their own discrete asset class, are designed with the goal of delivering returns that are in line with historical assumptions for equities while maintaining a far narrower range of performance (i.e., a substantially higher Sharpe ratio) and downside protection that can limit losses. Moreover, in a market in which yield has become difficult to find, the construct of equity buy/writes, coupled with bottom-up fundamental analysis, can create a synthetic yield instrument that delivers uncorrelated returns and manages to capitalize on volatility rather than being subjected to it.”
Adds Hawthorne, “Traditionally, when retail investors discuss “low volatility” strategies, they are referring to an approach that combines diversification with systematic and regular rebalancing. These more traditional approaches — be it Shannon’s Demon, the Kelly Criterion, or other variations — are more about circumventing volatility than actually capitalizing on it with true downside protection and improved return profiles…
However, other strategies that combine both equities and equity call options — or buy/write securities — can more effectively “harvest” returns out of swings in sentiment, while providing more predictable, and often better, performance even as volatility ramps up. The concept of creating synthetic yield isn’t necessarily new, as portfolio managers will often invest in buy/writes on a basket of stocks tied to an index as a way to generate returns that are in line with the market over time, but at slightly reduced volatility and with the added benefit of options income..”
To read the entire P&I article, please click here