In The News

ASX takes new benchmark option

The Age
15 June 2004
Peter Weekes

Retail investors and fund managers will soon have a new performance benchmark for their investments, with the Australian Stock Exchange expected to announce a new index today.

The index is based on an investment strategy known as buy-write, which involves buying a stock and then "writing" an out-of-the-money call option against it - known as a covered call.

The current measure, the S&P/ASX 200 Accumulation Index, which replaced the All Ordinaries Accumulation Index in March 2000, will remain, but it is believed the ASX hopes its new Buy-Write Index will raise the bar, and returns, for investors. The strategy, widely used in the US and Australia, is a way of generating returns above those expected from "hugging" the benchmark S&P/ASX index - that is, merely matching its performance.

The writer, or seller, of an option pockets a premium, or fee, from another party that entitles the party to call for delivery of the stock at a prearranged price, known as the strike price.

The writer chooses a strike price above the level he thinks the stock will reach, meaning the option will not be exercised, leaving him with the original shares plus the option fee.

Earlier this year, a study of the strategy by the Securities Industry Research Centre of Asia-Pacific (SIRCA) showed that over the five years to December 2000 the return on the buy-write portfolio averaged an annual 11.8 per cent, compared with 9.5 per cent from the S&P/ASX 200.

It also found the risk of the buy-write strategy was less than hugging the S&P/ASX 200 - 5.78 per cent against 6.15 per cent respectively.

"On both a total-risk and beta-risk adjusted basis, the buy-write strategy outperforms the index portfolio," the report said. "We conclude that a buy-write strategy appears to be profitable in the Australian market."

We conclude that a buy-write strategy appears to be profitable in the Australian market.
SIRCA studyThe Chicago Board Options Exchange launched its own buy-write monthly index (BXM) in April 2002, following a study by options pricing theorist Robert Whaley. He also found that the strategy outperformed the US S&P 500.

"For more than 25 years, portfolio managers have employed buy-write strategies to provide incremental income to boost risk-adjusted returns and provide a cushion against downside losses," CBOE chairman and chief executive William Brodsky said at the time.

"BXM is exactly the tool every money manager needs to measure the performance of these portfolios and compare buy-write portfolio performance to other benchmark indexes."

However, while the strategy helps cushion downward moves on the market, it often underperforms in rising markets.