In The News

ASX may start a buy-write index

Australian Financial Review
18 February 2004
Chris Wright

The Australian Stock Exchange is considering starting a new index based on an investment strategy known as a buy-write.

This strategy, widely used in the US and Australia, involves an investor buying a stock and also writing a call option against that stock. It is also known as a covered call.

It's a way of generating extra income because by writing (that is, selling) the option, the investor gets a fee.

In return, the person who buys that option gets the right to buy your share at a certain price.

The strategy makes sense if you think the stocks you own aren't going to move far - meaning the option you sell probably won't be exercised and will instead expire worthless, leaving you with your original stock plus the fee for writing the option.

The ASX this week released a report from the Securities Industry Research Centre of Asia Pacific which compared returns from the S&P/ASX200 Index with a buy-write strategy over 60 quarters from 1988 to 2003.

The study assumed the investor owned the underlying index and wrote a slightly out-of-the-money call option.

Over that period, the buy-write strategy produced returns 23 per cent higher than those produced by the S&P/ASX 200 Accumulation Index - and with a lower risk profile.

The return follows similar studies in the US, notably a 2002 research effort by options pricing theorist Robert Whaley that concluded a buy-write strategy outperformed the S&P 500 index.

There, the strategy has become so popular the Chicago Board of Exchange has launched a buy-write index that is used by US equity portfolio managers.

An index "gives the market a reference point for fund managers to compare themselves against and also to observe how the strategy is performing in general", said Michael Saba, a senior derivatives analyst at Goldman Sachs JBWere.

"For retail investors, it would be a guide to the returns that could be achieved," he said.

"Buy-writes are a very common strategy but previously there was an absence of any yardstick showing how the market conditions are and what can be achieved in them."

Mr Saba said the findings of the report would be achievable but he said returns from the strategy would vary with market conditions.

"Generally when volatility is high, you would expect [a] buy-write index to return larger numbers - although the flip side is that increased volatility usually points to increased market risk as well,"' he said.