Cboe Global Markets

New Wilshire Paper Uncovers Where to Find Enhanced Risk-Adjusted Returns

February 20, 2020

New study highlights volatility risk premium for strategies that sell Russell 2000 options

With the low interest rate environment and steady bull market of recent years, lower yields and lower expected returns from “traditional” investments have left many investors wanting more. If you’re looking for new strategies that have the potential to harness the rich pricing of options and to enhance risk-adjusted returns, Wilshire Analytics may have a solution.

The recently published Wilshire Analytics whitepaper, “Improving Diversification by Harvesting Volatility Risk Premiums —The Cboe Russell 2000 Option Benchmark Suite,” provides an in-depth analysis of the performance of the Russell 2000 Small-Cap Index (RUT) against four Cboe Russell 2000 option-selling indexes and broad market indexes over a period of almost 19 years — from January 31, 2001 to December 31, 2019.

 Analyzed Indexes Include:

Enhanced Risk-Adjusted Returns

In its research, Wilshire Analytics found that the Cboe Russell 2000 Putwrite Index (PUTR℠) generated higher risk-adjusted returns (as measured by the Sharpe and Sortino Ratios) than five other indexes studied. The PUTR Index had a Sharpe Ratio that was 28% higher than the RUT Index, and a Sortino Ratio that was 20% higher than the RUT Index.

How did the PUTR Index generate superior risk-adjusted returns during a time period that included one of the longest equity bull markets in U.S. history? The implied volatility risk premium for RUT options was a key factor.

Richly Priced Index Options and the Implied Volatility Premium

As shown in the chart below, over almost 16 years, the average implied volatility of RUT options (based on the Cboe Russell 2000 Volatility Index (RVX)) was about 3.3 volatility points above the subsequent realized volatility of the RUT Index. The implied volatility risk premium facilitated stronger risk-adjusted returns for the PUTR Index (which sold richly-priced RUT puts) when compared to the CLLR Index (which both bought and sold RUT options) and the Russell 2000 Index.

Expanded Efficient Frontier How Can These Indexes Benefit a Traditional Portfolio?

As shown in the chart below, a 15% additional allocation of a Cboe PUTR Index to a traditional stock/bond portfolio, improved returns by 8 basis points and reduced risk from 21 to 57 basis points.

Key Findings from the Paper

  • Enhanced Risk-Adjusted Returns: The implied volatility risk premium fueled strong risk-adjusted returns for PUTR, as the Sharpe Ratio for PUTR was 28% higher than that of the Russell 2000 Index.
  • Richly Priced Options Premiums Harvested: All four Cboe strategy indexes sold RUT options and collected monthly premiums. BXR collected an average gross premium of 2.1%. RUT options were usually richly priced, as average implied volatility exceeded average realized volatility by about 3.3 volatility points.
  • Expanded Efficient Frontier: 15% additional allocation of PUTR to a traditional 60/40 stock-and-bond portfolio improved returns by 8 basis points, and reduced standard deviation by 21 to 57 basis points.
  • Improved Tail Risk and Lower Volatility: All four Cboe strategy indexes had lower volatility and maximum drawdowns than the Russell 2000 Index. PUTR had a 29% lower standard deviation and 28% less severe drawdown than the Russell 2000 Index.

Learn More at Cboe RMC

Join at Cboe Risk Management Conference (RMC) in Bonita Springs, Florida, for an in-depth analysis of these findings from Jeff Foley, Managing Director and Head of Business Operations at Wilshire Analytics.

Or, visit the websites below to read the whitepaper and learn more about how Cboe index options can facilitate enhanced premium generation and risk-adjusted returns.

Please note, this research was conducted by Wilshire Analytics and is designed for financial professionals.

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