Research & Whitepapers
RJA is a firm based on the belief that asset markets are efficient and, as such, the best approach to investment is based on rational economic analysis and academic research.
A Cash-Secured PutWrite strategy sells a put option and fully collateralizes the option with cash or cash equivalents, i.e. the collateral balance is equal to the maximum possible loss of the short put at expiration. Historically, Cash-Secured PutWrite strategies such as the Cboe S&P 500 PutWrite (PUT) Index have provided investors with equity-like returns with 2/3 of the volatility. Sometimes dubbed an “exotic” strategy, Cash-Secured PutWrite is often misunderstood and mischaracterized. In this article, we review five claims about Cash-Secured PutWrite strategies.
With recent market volatility and devastating performance of several short VIX ETPs, volatility strategies have come under the spotlight. This spotlight has muddled many short volatility strategies together and failed to discern key characteristics of different approaches. One specific comparison which warrants comment is Cash-Secured PutWrite and short VIX ETPs. In this whitepaper, we demonstrate that these two strategies have definitively different risk-return profiles and different dependencies on a low-vol environment.
The Volatility Risk Premium (VRP) has gained popularity among institutional investors in recent years. Nevertheless, being a concept framed in the derivatives securities space, it is not as well understood as other risk factors such as value, momentum, and size. In this whitepaper, we provide a brief introduction to VRP in a Q&A format, highlighting its outstanding risk-adjusted performance, diversification benefits, and protection against large drawdowns.
After eight years of market recovery, 65% of investment managers now believe that the US equity market is overvalued (Northern Trust Asset Management, 2017). While some investors believe the current state of higher valuations is justified due to the low-interest-rate environment, others have a more bearish view. In this whitepaper, we assess the risk-adjusted performance of a PutWrite strategy on the market for various degrees of market valuation. We find that the PutWrite strategy historically produced consistent alpha under all states of market valuation – undervalued, fairly-valued, as well as overvalued. It is interesting to observe that in richly-valued markets the PutWrite strategy allowed investors to participate in further market upside and, from collecting the volatility risk premium, obtained downside protection in the event of a correction.
We’re in the middle of a frenzy of factor focused investing. It seems as though every other article in the investment press talks about a new factor or how old ones are doing, or it reports a new mandate to manage factor tilts or factor-focused portfolios. I am certainly gratified to see the enormous amount of work inspired by the Arbitrage Pricing Theory (APT); but with the estimated asset allocation to factors approaching $1 trillion, perhaps it is time to step back and think a bit about the economic foundations of this effort before we get to $2 trillion.
Private equity (“PE”) is known for the attractive return potential it offers to institutional investors. Yet, investors often face a timing issue when investing with PE managers. While capital is committed to a PE fund at one point in time, it is generally called over an extended period. A recent study by Preqin1 shows that the amount of “dry powder”, i.e. the amount of committed capital that has not yet been called and is “parked” in liquid assets, has increased by nearly 50% since December 2012. In this paper, we discuss the use of option-based strategies to create synthetic PE exposure as committed capital waits to be deployed.
We can only estimate the distribution of stock returns, but from option prices we observe the distribution of state prices. State prices are the product of risk aversion - the pricing kernel - and the natural probability distribution. The Recovery Theorem enables us to separate these to determine the market's forecast of returns and risk aversion from state prices alone. Among other things, this allows us to recover the pricing kernel, market risk premium, and probability of a catastrophe and to construct model-free tests of the efficient market hypothesis.
Asset reallocation, or moving capital across asset risk classes, is commonly used to modify equity exposure in an investment portfolio. However, what comes with the lower risk is lower expected return and by reallocating to low risk asset classes, investors are giving up some of the upside potential if equity investment in exchange for directly proportional downside protection.
An alternative approach to asset allocation in general and to modifying equity exposure in particular is to add an option overlay portfolio to an unchanged equity portfolio. The non-linear nature of the option payoff profile may allow investors to achieve the same level of downside protection without giving up as much upside potential as in the asset reallocation approach. There are no free lunches though and the relevant tradeoff is between the advantages of the risk-return profile provided by options against the cost of the options used to implement the risk profile.
In this paper, we outline a framework to evaluate and compare the two approaches, and to inform a decision.