HISTORICAL PERFORMANCE OF PUT- WRITING STRATEGIES Oleg Bondarenko Professor of Finance University of Illinois at Chicago Cboe Risk Management Conference Carlsbad, March 25-27, 2019 Summary • This study analyzes historical performance of two put-writing indices: • Cboe S&P 500 PutWrite Index (PUT) • Cboe S&P 500 One-Week PutWrite Index (WPUT) • Compares it to the performance of traditional benchmarks: • S&P 500 • Russell 2000 • MSCI World • 30-year Treasury Bond (FTSE) as well as the option buying index • Cboe S&P 500 5% Put Protection Index (PPUT) Oleg Bondarenko University of Illinois at Chicago 2 Highlights • Long-term performance: Over 32+ years, PUT outperformed the traditional indices on a risk-adjusted basis. Compared to S&P 500, PUT has a comparable annual compound return, but a substantially lower risk: standard deviation, beta, maximum drawdown, etc. • Volatility risk premium: Since 1990, the option implied volatility (19.3%) has considerably exceeded the realized volatility (15.1%). • Lower risk: Relative to PUT and S&P 500, WPUT has lower risk (standard deviation, beta, and maximum drawdown). • Annual premium income: Since 2006, the average annual gross premium collected is 12*1.85% = 22.1% for PUT and 52*0.71 = 37.1% for WPUT. • Liquidity: Trading volume in Weekly S&P 500 options has increased 50+ times over the last 8 years. • PUT versus PPUT: Since 1986, the cumulative return is 1835% for PUT and 708% for PPUT. PUT has a negative exposure to the volatility risk, which accounts for 0.29% of its monthly return. PPUT has a positive exposure to the volatility risk, which accounts for -0.17% of its monthly return. Oleg Bondarenko University of Illinois at Chicago 3 What is a PUT-Write Strategy? • A cash-secured put-write strategy systematically sells options collateralized by risk-free investment. • The Cboe PUT Index tracks the performance of a hypothetical passive strategy that collects option premiums from at-the-money (ATM) puts on S&P 500 Index and holds a rolling money account invested in Treasury bills. • The strategy attempts to profit from high premiums of index options. Oleg Bondarenko University of Illinois at Chicago 4 Profit-and-Loss Diagram for ATM Put-Write Strategy 200 150 SPX Put-Write S&P 500 100 50 0 2300 2350 2400 2450 2500 2550 2600 2650 2700 -50 Profit-and-Loss -100 -150 -200 Index Value at Expiration Oleg Bondarenko University of Illinois at Chicago 5 Put-Write Example • S&P 500 = 2500, 1-month ATM Put = 57.57 (2.3%) • Put-Write outperforms S&P 500 if S&P 500 declines, stays flat, or slightly increases (up to 2.3%) • Underperforms S&P 500 if S&P 500 increases by more than 2.3%, but still makes profit of 2.3% • A good tradeoff? • Depends on whether Put premium is high enough on average • Not a “free lunch” Oleg Bondarenko University of Illinois at Chicago 6 Profit-and-Loss Diagram for ATM Put-Write Strategy 200 SPX Put-Write 150 S&P 500 100 "Fair" Premium 50 0 2300 2350 2400 2450 2500 2550 2600 2650 2700 Profit-and-Loss -50 -100 -150 -200 Index Value at Expiration Oleg Bondarenko University of Illinois at Chicago 7 Historical Prices of S&P 500 Puts are Too High • Bondarenko (2003), “Why are Put Options So Expensive” • Sample period is 08/87-12/00 • Buy-and-hold strategy; no hedging • Holding period = 1 month, from one option maturity to another • Puts of various moneyness k = K/S = 0.94, 0.96, …, 1.06 • Average excess returns are highly negative: ATM put (k = 1.00): -39% per month, OTM put (k = 0.94): -95% per month. • For ATM puts to break even, October 1987 crashes would have to occur every 9 months Oleg Bondarenko University of Illinois at Chicago 8 Wealth Transfer from Put Buyers to Put Sellers, Bondarenko (2003) Oleg Bondarenko University of Illinois at Chicago 9 Implied Versus Realized Volatility – Richly Priced S&P 500 Options 90 80 VIX Realized Volatility 70 60 50 40 30 20 10 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 VIX and 1-month realized volatility of S&P 500. The period is Jan 1, 1990 to Dec 31, 2018. Sources: Cboe Exchange, Inc. Oleg Bondarenko University of Illinois at Chicago 10 VIX minus Subsequent Realized Volatility - Annual Averages Implied S&P 500 Realized Year volatility (VIX) Volatility 10.0 1990 23.1 15.4 1991 18.4 13.6 7.7 1992 15.5 9.4 8.0 7.4 6.9 1993 12.7 8.3 6.3 1994 13.9 9.5 6.1 6.2 6.1 6.0 1995 12.4 8.1 6.0 5.0 5.2 1996 16.4 11.5 4.8 4.8 4.5 4.5 1997 22.4 17.6 4.34.44.2 4.3 1998 25.6 18.7 4.0 3.4 3.4 3.43.1 1999 24.4 18.1 2.7 2.2 2000 23.3 21.6 1.7 1.8 1.9 2001 25.7 19.7 2.0 2002 27.3 25.1 0.7 2003 22.0 15.7 2004 15.5 11.0 0.0 2005 12.8 10.1 2006 12.8 9.4 2007 17.5 15.8 -2.0 2008 32.7 35.2 2009 31.5 24.1 -2.5 2010 22.5 16.5 2011 24.2 20.8 -4.0 2012 17.8 12.6 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2013 14.2 10.8 2014 14.2 11.1 VIX minus subsequent 1-month realized volatility of S&P 500. The period is Jan 1, 2015 16.7 14.3 2016 15.8 11.3 1990 to Dec 31, 2018. The average difference (4.2) is shown with the horizontal 2017 11.1 6.8 2018 16.6 15.9 All Oleg Bondarenko19.3 15.1 University of Illinois at Chicago 11 Growth of Benchmark Indices Since Jun 30, 1986 25.0 S&P 500, $20.85 PUT PPUT S&P 500 20.0 Russell 2000 MSCI World Tbond PUT, $19.35 Tbill 15.0 Russell 2000, $14.16 10.0 5.0 MSCI World, $10.22 PPUT, $8.08 0.0 Tbond, $5.70 Tbill, $2.81 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 The value of $1 invested in PUT, PPUT, S&P 500, Russell 2000, MSCI World, 30-year Tbond (FTSE), and 30-day Tbill. The period is from Jun 30, 1986 to Dec 31, 2018. Past performance is not predictive of future returns. Sources: Bloomberg and Cboe Exchange, Inc. Oleg Bondarenko University of Illinois at Chicago 12 Return Versus Standard Deviation 12% PUT S&P 500 9% Russell 2000 MSCI World PPUT 6% 3% Tbill 0% 0% 5% 10% 15% 20% 25% 30% Annual compound return versus standard deviation for PUT, PPUT, S&P 500, Russell 2000, MSCI World Indices. The period is from Jun 30, 1986 to Dec 31, 2018. Sources: Bloomberg and Cboe Exchange, Inc. Oleg Bondarenko University of Illinois at Chicago 13 Monthly Statistics (Jun 30, 1986 to Dec 31, 2018) Russell MSCI 30-year 30-day PUT PPUT S&P 500 2000 World Tbond Tbill Mean Return 0.81% 0.60% 0.88% 0.84% 0.69% 0.59% 0.27% Compound Return 0.76% 0.54% 0.78% 0.68% 0.60% 0.53% 0.27% Min Return -17.65% -10.60% -21.54% -30.63% -18.96% -14.61% 0.00% Standard Deviation 2.87% 3.49% 4.31% 5.54% 4.31% 3.51% 0.21% Skewness -2.09 -0.28 -0.81 -0.88 -0.67 0.25 0.24 Kurtosis 12.58 3.52 5.48 6.07 4.79 5.64 1.87 Alpha 0.20% -0.12% 0.00% -0.07% -0.12% 0.38% 0.00% Beta 0.56 0.74 1.00 1.06 0.89 -0.08 0.00 Sharpe Ratio 0.19 0.10 0.14 0.10 0.10 0.09 SortinoRatio 0.25 0.14 0.20 0.14 0.14 0.15 Stutzer Index 0.18 0.09 0.14 0.10 0.10 0.09 M-squared 1.08% 0.68% 0.88% 0.71% 0.69% 0.67% Oleg Bondarenko University of Illinois at Chicago 14 Annualized Statistics (Jun 30, 1986 to Dec 31, 2018) Russell MSCI 30-year 30-day PUT PPUT S&P 500 2000 World Tbond Tbill Compound Return 9.54% 6.64% 9.80% 8.50% 7.41% 6.60% 3.24% Standard Deviation 9.95% 12.08% 14.93% 19.18% 14.92% 12.16% 0.74% Sharpe Ratio 0.65 0.33 0.49 0.36 0.34 0.32 SortinoRatio 0.85 0.48 0.70 0.50 0.48 0.51 Stutzer Index 0.61 0.33 0.48 0.35 0.34 0.33 Oleg Bondarenko University of Illinois at Chicago 15 Annualized Sharpe Ratio, Sortino Ratio, and Stutzer Index 1.0 PUT PPUT S&P 500 Russell 2000 MSCI World Tbond 0.9 0.85 0.8 0.70 0.7 0.65 0.61 0.6 0.49 0.50 0.51 0.5 0.48 0.48 0.48 0.4 0.36 0.33 0.340.32 0.33 0.350.340.33 0.3 0.2 0.1 0.0 Sharpe Ratio Sortino Ratio Stutzer Index Annualized Sharpe Ratio, Sortino Ratio, and Stutzer Index for PUT, PPUT, S&P 500, Russell 2000, MSCI World, 30-year Tbond (FTSE).