“Where people inevitably make missteps in the derivatives market is by making tactical decisions that result in illiquid positions, too much leverage, and/or too much complexity. I sometimes refer to illiquidity, leverage and complexity as the Bermuda Triangle of option investing.”
selling in a short window every third Friday, other traders would
take advantage of it and returns would inevitably suffer. The
rules of equity investing don’t apply.
CIO: What percentage of their portfolios are your clients
allocating to these strategies, where are they taking the
money from, and how are they classifying their positions?
DEVENS: It varies, but we are seeing many allocate something
like 5% to 10% of their equity portfolios to these strategies. The
money is coming from a variety of other asset classes—hedge
funds are one source—but regardless of where it comes from the
rationale is often the same. Investors see that these strategies
can be an attractive return source that’s index-based, liquid,
transparent and cost-effective. Many investors consider it part
of their equity allocation, but that’s a little fluid right now. Most
of our conversations are around what it is and how it works, and
then clients are determining for themselves, often working with
their boards or their consultants, how to classify and where this
strategy most appropriately fits within their asset allocation mix.
CIO: How fast are these strategies growing, and what kinds
of asset owners are showing the most interest?
DEVENS: I’ve been doing this over six years now, and over the
last 12 to 18 months we’ve really started to see these strategies
gain traction across the board, from health care foundations to
big public retirement systems, to smaller municipal retirement
plans and even high-net-worth individuals. We’ve raised over $1
billion in the last 12 months.
CIO: Options are a form of derivatives, and in the eyes of
some asset managers, derivatives still denote risk, not risk
mitigation. What would you want someone concerned about
risk to know about these strategies?
DEVENS: First, our strategy really isn’t any riskier than owning
equities outright. In fact, I’d argue it’s less risky, in part because
the option position is 100 percent collateralized by short-term
U.S. Treasuries which means an investor has enough to cover
a maximum loss, the index going to zero. We’re not using any
leverage. And while our strategy translates into less up-market
participation, it has generally resulted in a lower drawdown when
the stock market has fallen. My second point goes to complexity
and liquidity. We keep things very simple. We only trade listed
or exchange-traded index options, avoiding less liquid over-
the-counter structures. Finally, we employ a systematic, not
a tactical, approach to trading. Where people inevitably make
missteps in the derivatives market is by making tactical decisions
that result in illiquid positions, too much leverage, and/or too
much complexity. I sometimes refer to illiquidity, leverage and
complexity as the Bermuda Triangle of option investing; you
really don’t want to fly through all three of those at once. We
stay clear of all three all the time.
CIO: Which indexes do you use for your options strategies?
DEVENS: Most investors want to source their options
premiums from broad-based indexes that match their current
equity exposure. The indexes we run, or manage against, for our
clients currently include the S&P 500, the MSCI EAFE, the MSCI
Emerging Markets and the Russell 2000 indexes. Put-writing
and strangle strategies have enough diversification benefits and
tracking error to the index that clients don’t need to add to it by
doing off-benchmark option-writing.
CIO: You mentioned that you take a rules-based approach
to your options strategies. What are some of the rules, or
variables, that you use to implement your strategies?
DEVENS: We diversify across expiration dates and strike prices,
and we also methodically rebalance options to promote a better,
more stable option portfolio.
CIO: You must get this last question a lot. What kind of
return profile can investors expect from these strategies?
DEVENS: Historically, putwrite strategies have generated equity-like returns, but with a different return distribution—less volatility,
less drawdown in down markets but also less participation
in significantly up markets, than the underlying index. For
example, since 2007, the CBOE S&P 500 Put Write Index (PUT)
has typically outperformed the S&P 500 in modest, flat and
down markets but lagged in strong up markets, with S&P 500
returning 7.18% and the PUT index returning 6.35% annualized
during this period. n
6/21/17 3:43 PM