FOR INSTITUTIONAL INVESTOR USE ONLY ALPHA GENERATION A GUIDE FOR SMART OVERWRITING Global Equity Flow Engineering and Strategy Delphine Leblond-Limpalaër, CFA delphine.leblond@sgcib.com +44 20 7762 5771 October 1 st, 2013 NOT FOR DISTRIBUTION IN THE US
OVERWRITING AT A GLANCE : A LONG TERM SOURCE OF ALPHA 10% Overwriting outperformance 8% 6% 4% 2% 0% -2% -4% 2006 2007 2008 2009 2010 2011 2012 2013 EuroSTOXX 50 Stocks -6% Source: SG Cross Asset Research, SG Global Engineering & Strategy THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PERFORMANCES REFER TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA. 2
THAT REDUCES THE VOLATILITY OF THE PORTFOLIO Standard deviation of performance (2006-2013) Single Stocks EuroSTOXX 50 Long + overwriting Long only 0% 2% 4% 6% 8% 10% 12% Source: SG Cross Asset Research, SG Global Engineering & Strategy THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PERFORMANCES REFER TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA. 3
% of occurrence WHAT IS INFLUENCING OVERWRITING PERFORMANCE? 6% Distribution of the monthly returns of the STOXX600 members over the 2000-2013 period 5% 4% 3% 87% 2% 1% 13% 0% -30% -20% -10% 0% 10% 20% 30% Source: Bloomberg, SG Global Engineering & Strategy monthly returns % THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PERFORMANCES REFER TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA. 4
IV 30 days lagged RV WHAT IS INFLUENCING OVERWRITING PERFORMANCE? "I'd be a bum on the street with a tin cup if the markets were efficient " - Warren Buffett EuroSTOXX 50 implied vs. realised volatility 60 overpriced volatility 40 20 66% of positive P&L 0-20 -40-60 0 10 20 30 40 50 60 70 80 90 underpriced volatility Source : SG Cross Asset/Derivatives, SG Global Engineering and Strategy 1M ATM Implied Volatility THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PERFORMANCES REFER TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA 2005 2006 2008 2007 2009 2010 2011 2012 2013 5
IV - 30 days lagged RV WHAT IS INFLUENCING OVERWRITING PERFORMANCE? 30 20 EuroSTOXX 50 Implied vs. realised volatility when the market is up overpriced volatility 10 82% of positive P&L 0 0 10 20 30 40 50 60 70 80 90-10 -20-30 underpriced volatility -40 1M ATM Implied Volatility Source: SG Cross Asset Research/Derivatives, SG Global Engineering and Strategy THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PERFORMANCES REFER TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA. 6
WHAT IS INFLUENCING OVERWRITING PERFORMANCE? When is implied volatility overpriced? Industrials Energy Materials Consumer Discretionary Financials Utilities Health Care Consumer Staples EuroSTOXX 50 Telecommunication Services 50% 52% 54% 56% 58% 60% 62% 64% 66% 68% Source: SG Cross Asset Research, SG Global Engineering & Strategy, % of observations when lagged 1M realised IV ends below 1M ATM IV, 2005-2013, current index THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PERFORMANCES REFER TO PA ST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA. 7
AVOIDING THE TAIL RISK IN AN OVERWRITING STRATEGY 1. Index : use a momentum indicator RSI30 signal with a threshold at 50 vs. S&P 500 1800 Pink (bear) blue (bull) S&P 500 spot 1600 1400 1200 1000 800 600 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source : SG Equity Derivatives Strategy THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PAST PERFORMANCES REFER TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA. 8
AVOIDING THE TAIL RISK IN AN OVERWRITING STRATEGY 2. Stocks : criteria to decrease the probability of big upward movers Expensive valuation No low/negative skew Recent strong performance No significant short interest Not in SG Event prediction list No major catalyst 9
Call price (% spot) THE VERY GOOD ENEL 2.0 1.8 3.8 1.6 1.4 3.3 1.2 1.0 0.8 2.8 0.6 0.4 2.3 0.2 1M 25% delta call price stock price 0.0 May-12 Aug-12 Nov-12 Feb-13 1.8 Source: VolHub, SG Global Engineering & Strategy THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PERFORMANCES REFER TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA. 10
THE GOOD Total: invest 100 in 2004 200 spread Long only Overw riting 30 180 25 160 20 140 15 120 10 100 5 80 01-Sep-04 01-Sep-05 01-Sep-06 01-Sep-07 01-Sep-08 01-Sep-09 01-Sep-10 01-Sep-11 01-Sep-12 0 Source: SG Cross Asset Research, SG Global Engineering & Strategy THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PERFORMANCES REFER TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA. 11
AND THE UGLY KPN 20.0 3.0 15.0 1M 90%-110% skew Stock price (lhs) 2.8 2.6 10.0 2.4 5.0 2.2 0.0 2.0-5.0 1.8 1.6-10.0 1.4-15.0 1.2-20.0 1.0 Source: SG Cross Asset Research, SG Global Engineering & Strategy THE VALUE OF YOUR INVESTMENT MAY FLUCTUATE. THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PERFORMANCES REFER TO PA ST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA. 12
STOCK VS. INDICES OVERWRITING A matter of : Liquidity Strategy Opportunity 13
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