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Reflecting the current popularity of low-volatility investment products, the Chicago Board Options Exchange (CBOE) has introduced the CBOE Low Volatility Index (LOVOL), a new benchmark index designed for investors seeking more stable returns.
The index aims to provide investors with the ability to replicate an investment strategy that is subject to less downside volatility in a portfolio of S&P 500 stocks, while still preserving the bulk of market gains.
The CBOE has built up a strong franchise in the volatility space and, within the world of indexing at least, is best known for the closely-watched CBOE Volatility Index (VIX), Wall Street’s so-called ‘Fear Gauge’.
The addition of the LOVOL extends the exchange operator’s volatility line-up, which already includes more than two dozen volatility-related benchmarks and strategies.
The new index is a 40% / 60% blend of the CBOE S&P 500 BuyWrite Index (BXM) and the CBOE VIX Tail Hedge Index (VXTH), two of CBOE’s most popular strategy benchmark indices. Combined, these indices cushion returns against market downturns in exchange for lower returns in more bullish markets, while also providing substantial protection against severe downturns in exchange for lower returns in less volatile markets.
The index is obtained by holding a portfolio of S&P 500 stocks and simultaneously selling S&P 500 Index (SPX) calls and buying one-month VIX calls. The mix of these options reduces the chance of shortfalls below -10% but still preserves the bulk of market gains.
The index’s past performance is appealing and will likely prove enticing to investors. For the five-year period ending October 31, 2012, the index achieved an annualised return of 2.9% (versus 0.4% for the S&P 500 total return index), with a standard deviation of 13.6% (versus 19.1% for the S&P 500).
As with the CBOE’s other volatility-related indices, such as the VIX, the LOVOL has the credentials to form the basis of an exchange-traded fund (ETF), thus providing investors with a vehicle to access the strategy. Variants of the VIX, for example, underlie a number of exchange-traded products including the popular iPath S&P 500 VIX Short-Term Futures ETN (VXX) from Barclays, which has more than $1.2 billion in assets. An ETF on the LOVOL could be constructed with relative ease, via either a synthetic or physical replication approach.
Indeed, the index’s two components, the S&P 500 BuyWrite and VIX Tail Hedge indices, already underlie existing physical ETFs, namely the PowerShares S&P 500 BuyWrite Portfolio ETF (PBP) and the First Trust CBOE S&P 500 VIX Tail Hedge ETF (VIXH), both of which are listed on the NYSE Arca.
With this in mind, sophisticated investors could potentially blend these two funds together in the same 40% / 60% ratio to create their own version of the strategy.