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New Study Finds That Certain Options- And Futures-Based Benchmark Indexes Could Help Manage Tail Risk Of Traditional Indexes

Date 12/03/2012

The merits of using options-based and futures-based strategy benchmark indexes to hedge and manage tail risk is the subject of a new study — "Key Tools for Hedging and Risk Management" — released today by investment-advisory firm Asset Consulting Group (ACG). 

The study, the second of two ACG papers commissioned by Chicago Board Options Exchange (CBOE), compares the performance of "traditional" indexes with the performance of five strategy benchmark indexes that use index options or VIX® futures: the CBOE S&P 500 95-110 Collar Index (CLL), CBOE VIX Tail Hedge Index (VXTH), S&P 500 VIX Mid-term Futures Index (VXMT), S&P 500 Dynamic VIX Futures Index (DyVX), and S&P 500 VIX Futures Tail Risk Index - Short Term (VTRsk).

The study focuses on two different time periods: 25-1/2 years (back to mid-1986) for the CLL Index, and 70 months (back to April 2006) for the four VIX-based benchmark indexes. VIX Index options opened for trading in February 2006.

Highlights of the Study:

  • Left Tail Risk in the Past 25 Years: In recent years, many investors have become concerned about mitigating the risk of large portfolio losses, also known as "tail risk."  The study showed that over the past 25 years, the worst monthly loss for the S&P 500® Index was a decline of 21.5 percent, compared to a decline of 28.2 percent for the S&P GSCI (commodity) Index, and a relatively modest 8.6-percent monthly decline for the CLL Index.
  • Tail Risk and Diversification in 2008: In 2008, the S&P 500 Index declined by 37 percent; the VXTH Index (with an allocation to stocks and VIX options) declined by 19.3 percent; and the VXMT Index increased by 83.9 percent.
  • Lower Volatility: The CLL Index has incurred about 70 percent of the volatility of the S&P 500 over the last 26 years. Select portfolios with the VXTH and the futures-based indexes have had less volatility than the S&P 500 over the last 70 months.
  • Enhanced Returns for Portfolios: Portfolios with small allocations to the futures-based indexes and the VXTH had higher returns and lower volatility than the S&P 500 over the past 70 months.

Overview of Strategy Benchmark Indexes Used in the Study:

  • CBOE S&P 500 95-110 Collar Index (CLL):  Buys three-month out-of-the-money S&P 500 put options at 95% of the S&P 500 value. Sells one-month out-of-the-money S&P 500 call options at 110% of the S&P 500 value.
  • CBOE VIX Tail Hedge Index (VXTH):  Buys one-month 30-delta VIX call options. The weight of the VIX calls in the portfolio varies at each roll depending on the perceived likelihood that a "black swan" event could occur in the near future.
  • S&P 500 VIX Mid-term Futures Index (VXMT):  Buys a combination of VIX futures positions in order to reflect the expectations of the VIX Index level in five months. Some of the VIX futures are rolled daily in order to maintain a constant average weighted five-month term.
  • S&P 500 Dynamic VIX Futures Index (DyVX):   Buys a combination of VIX futures positions to reflect dynamic allocation between the S&P 500 Short-Term VIX Futures Index and S&P 500 Mid-Term VIX Futures Index. The rules-based allocation is done with the goal of aiming to lower the roll cost of investments linked to future implied volatility.
  • S&P 500 VIX Futures Tail Risk Index - Short Term (VTRsk): Calculated using a weight of 45 percent of 2x the S&P VIX Short-Term Futures Index and 55 percent of the Inverse S&P 500 Short-Term Futures Index. The goal of the index is to provide a long volatility exposure whose cost is partially or completely mitigated (due to negative roll yield) via a rebalanced short exposure.

The new study is one of two commissioned studies recently completed by Asset Consulting Group that involve benchmark indexes that may be used for risk-management purposes.  Last month, ACG released "An Analysis of Index Option Writing for Liquid Enhanced Risk-Adjusted Returns," which covers the merits of using options-based strategy benchmark indexes to construct a diversified portfolio.   

In their continuing efforts to provide education for institutional investors, CBOE and Standard & Poor's Financial Services provided funding for this study.  The full Asset Consulting Group studies, as well as a complete listing of CBOE's previously commissioned options-based strategy studies, can be found at www.cboe.com/benchmarks.