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moneysense.ca, 1/06/11
Past Performance of the CBOE S&P 500 BuyWrite Index (BXM)
With the introduction of new ETFs that employ the covered call options strategy, it is instructive to take a look at the past performance of such strategies. The CBOE S&P 500 BuyWrite Index (BXM) tracks the performance of a hypothetical buy-write strategy on the S&P 500 Index. The Index is computed by writing one month, slightly out-of-the-money call options on a S&P 500 Index portfolio and adding the change in value of the call premium to the change in value of the S&P 500 Index plus dividends.
In a 2004 paper, Ibbotson Associates analyzed the returns and standard deviation of BXM over a 16 year period between 1988 and 2004. During that period, the BXM index returned 12.39%, slightly higher than the 12.20% return of the S&P 500. However, BXM achieved returns comparable to the S&P 500 with a lot less volatility: standard deviation was just 10.99% for BXM compared to 16.5% for the S&P 500. As one would expect, the report found that BXM outperformed a long-only S&P 500 in bear markets but trailed the index in bull markets. The report also suggests some reasons for the superior risk-adjusted performance of BXM and suggests that such outperformance should continue in the future.
Another study by Callan Associates that analyzed BXM’s performance from 1988 to 2006 reached similar conclusions. It found that BXM returned 11.77% annually with a 9.29% standard deviation compared to 11.67% from the S&P 500 with a standard deviation of 13.89%. Note that though both these studies employed the lower bid price for the call options, investable products based on BXM might have much higher transaction costs and taxes than products tracking plain vanilla indexes.
moneysense.ca, 1/06/11
Potential typo in the standard deviation numbers in the Callan Associates study. You seem to note a standard deviation of 9.29% for both the BXM and S&P 500. From the Callan Associates study you linked to:
” The compoundannual return of the BXM Index since June 1, 1988 is11.77 percent, compared to 11.67 percent for the S&P 500. The BXM returns were generated with a standard deviation of 9.29%, two-thirds of the 13.89% volatility of the S&P 500. “
Thanks for the catch 0xcc. I’ve updated the post.
These figures don’t speak very well for this strategy. The outperformance was 0.19% per year in one case and 0.10% per year in the other. This could easily be consumed by option transaction costs, as you say. Unless there is some reason to believe that the time period studied is unusually poor for this covered call strategy, I’m content to stick with index buy-and-hold.
@Michael: I don’t see a compelling reason to buy into the covered call strategy either. I have no interest in converting capital gains into income. In a taxable portfolio, that alone would rule these ETFs out for me.
I think you guys are missing the point. Passive investors usually buy into modern portfolio theory. This strategy lowers risk (as they define risk as volatility which is ridiculous in my opinion but anyway). A strategy such as this whereby you get the same return with less risk allows an investor to a greater proportion of their allocation to risky assets and this increases returns
Covered calls is no free lunch and I am not for or against it. I just thought all the passive investors would be all over risk component in this study yet not one commenter mentioned it.
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