CBOE Strategy Benchmarks

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1 White Paper CBOE Strategy Benchmarks Differences Between CBOE Strategy Benchmarks June 2013 by Catherine Shalen

2 Differences Between CBOE Strategy Benchmarks 2 CBOE is the leading Exchange in designing benchmark indexes that track the values of structured portfolios. A structured portfolio follows a rule-based strategy that overlays options on investments in correlated assets. Adding options to the mix reshapes the distribution of asset returns and creates different levels of protection against the risk of negative returns or, alternatively, new yield enhancing combinations. To help investors determine which CBOE benchmarks may best fit their risk preferences, this paper lays out charts and statistics that highlight the distinctive features of the distributions of benchmark returns. This approach provides a detailed perspective that describes portfolio performance with greater precision than standard risk-adjusted measures based on moments of the distribution. CBOE Strategy Benchmarks in a Nutshell

3 Differences Between CBOE Strategy Benchmarks 3 II. Frequency Distributions of CBOE Benchmarks Returns Charts 1 and 2 represent the historical frequencies of one month rolling returns of CBOE benchmarks for each return bracket (frequencies on vertical axes). They provide a nuanced characterization of relative performance that highlights the tradeoffs implicit in each benchmark s design and how they vary from benchmark to benchmark. Chart 1. Frequencies of Rolling One-Month Returns (Data in Table 1) Chart 2. Frequencies of Rolling One-Month Returns (Data in Table 2) Each bar in Charts 1 and 2 stacks the frequencies of a benchmark s rolling one-month returns in different brackets. The red bars represent tail risk, defined as monthly returns below -10%. The black bars represent returns above 10%. The light gray and dark gray bars mark core negative and positive returns, between -10% and 0% and between 0% and 10% respectively.

4 Differences Between CBOE Strategy Benchmarks 4 CBOE S&P 500 BuyWrite Index (BXM) and CBOE S&P 500 PutWrite Index (PUT) Charts 1 and 2 illustrate that the strength of buywrite/putwrite indexes as a group lies in providing a progression of cushions against core negative returns of the S&P 500 Total Return Index (SPTR), and a higher frequency of positive core returns. For example, the BXY has a 31% frequency of core negative returns and a 65% of core positive returns versus 34% (60%) core negative (positive) returns for SPTR. The BXM betters this with a 29% frequency of core negative returns, and a 68% frequency of core positive returns because it sells at-the-money instead of 2% out-of-the money calls. The BXM and PUT are similar but the different design of the PUT makes it more sensitive to S&P 500 and this leads to better core returns. The tradeoff for buywrite/putwrite indexes within the group and relative to other benchmarks is fewer returns in the right tail, above 10%. In sum, buywrite/putwrite indexes tend to perform relatively better in the center core of the distribution, not in the tails. This suggests that moderately risk averse investors who do not weigh tail risk heavily may veer toward buywrite/putwrite indexes. CBOE VIX Tail Hedge Strategy Index (VXTH), CBOE Low Volatility Index SM (LOVOL), and CBOE S&P Collar Index (CLL) VXTH, LOVOL, and CLL are protective benchmarks that target tail risk, or monthly returns below -10%. The CLL tends to have the lowest tail risk, in fact none at all in the period under consideration compared to 1% for VXTH and LOVOL. It is likely suited to the most risk-averse investors. The tradeoff is an increase in the frequency of core negative returns: 45% versus 36% for VXTH, and no positive tail returns. The VXTH has less tail risk than buywrite/putwrite indexes, and a fatter right tail, but more frequent core negative returns. LOVOL is designed to generate a less volatile path of returns than the VXTH with a higher frequency of core returns and fewer extreme returns. CBOE VIX Premium Strategy Index (VPD) and CBOE Capped VIX Premium Strategy Index (VPN) Unlike the previous benchmarks, the objective of VPD and VPN is not to hedge, but to capture a volatility premium by selling VIX futures. Accordingly, VPD and VPN have the highest frequency of positive tail returns, and the highest tail risk as tradeoff. VPD and VPN typically have more frequent core positive returns than tail risk indexes but less frequent core positive returns than buywrite/putwrite indexes. They rank better than tail risk indexes for core negative risk and are close to buywrite/putwrite indexes for core negative returns. VPD and VPN are likely to appeal to investors with low risk-aversion who are looking to enhance yield.

5 Differences Between CBOE Strategy Benchmarks 5 Table 1. Summary Statistics Rolling One Month Returns Table 2. Summary Statistics Rolling One Month Returns

6 Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies are available from your broker, by calling OPTIONS, or from The Options Clearing Corporation at The information in this article is provided solely for general education and information purposes. No statement within this article should be construed as a recommendation to buy or sell a security or futures contract or to provide investment advice. Past performance does not guarantee future results. Supporting documentation for any claims, comparisons, statistics or other technical data in this document is available from CBOE upon request. Visit www. cboe.com/benchmarks for more information. CBOE, Chicago Board Options Exchange and VIX are registered trademarks and BuyWrite, BXM, BXY, CLL, LOVOL, PutWrite, PUT, VPD and VPN are service marks of Chicago Board Options Exchange, Incorporated (CBOE). S&P and S&P 500 are trademarks of Standard & Poor s Financial Services, LLC and have been licensed for use by CBOE. CBOE s options based on S&P indices are not sponsored, endorsed, sold or promoted by Standard & Poor s, and Standard & Poor s makes no representation regarding the advisability of investing in such products. About CBOE Holdings, Inc. CBOE Holdings, Inc. (NASDAQ: CBOE) is the holding company for Chicago Board Options Exchange (CBOE), the CBOE Futures Exchange (CFE) and other subsidiaries. CBOE, the largest U.S. options exchange and creator of listed options, continues to set the bar for options and volatility trading through product innovation, trading technology and investor education. CBOE Holdings offers equity, index and ETF options, including proprietary products, such as S&P 500 options (SPX), the most active U.S. index option, and options and futures on the CBOE Volatility Index (the VIX Index). Other products engineered by CBOE include equity options, security index options, LEAPS options, FLEX options, and benchmark products such as the CBOE S&P 500 BuyWrite Index (BXM). CBOE Holdings is home to the world-renowned Options Institute and the go-to place for options and volatility trading resources. CBOE is regulated by the Securities and Exchange Commission (SEC), with all trades cleared by the OCC. CBOE 400 South LaSalle Street Chicago, IL The information in this paper is not intended and should not be construed to constitute investment advice or recommendations to purchase or sell securities. CBOE Volatility Index and VIX are registered trademarks of Chicago Board Options Exchange, Incorporated (CBOE). Copyright 2013 Chicago Board Options Exchange, Incorporated. All rights reserved.