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S&P Buy-Write Index ETN Info leaked?
Old 05-21-2007, 10:12 AM   #1
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S&P Buy-Write Index ETN Info leaked?

I have a google alert set up to watch for the release of the iPath BuyWrite ETN that I have heard mentioned for the past year or so. It looks like iPath is getting ready to release it on May 22-23, since I got an alert, but at the same time, it is not listed on the iPath site directly! Gotta love automatic crawlers

It looks to be pretty pricey, but you get the ETN structure. This is both good and bad.

Good: Perfect index tracking excluding fees (very good thing since this is following a derivatives strategy, which could have lots of tracking error due to wide spreads and not enough liquidity).

Bad: Taking on credit risk of Barclays

Leaked info sheet:

http://www.ipathetn.com/pdf/BWV_termsheet.pdf

Will trade under the symbol BWV. Priced every Thursday, Expense Ratio looks to be 0.75%


Does this sound normal for pricing structure?

Quote:
The investor fee is equal to 0.75% per year times the principal amount of your Securities times the index factor, calculated on a daily basis in the following manner: The investor fee on the inception date will equal zero. On each subsequent calendar day until maturity or early redemption, the investor fee will increase by an amount equal to (1) 0.75% times (2) the principal amount of your Securities times (3) the index factor on that day (or, if such day is not a trading day, the index factor on the immediately preceding trading day) divided by (4) 365.
Is this how most expense ratios are calculated?

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Re: S&P Buy-Write Index ETN Info leaked?
Old 05-21-2007, 11:44 AM   #2
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Re: S&P Buy-Write Index ETN Info leaked?

Can someone explain the buy/write index?
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Re: S&P Buy-Write Index ETN Info leaked?
Old 05-21-2007, 12:03 PM   #3
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Re: S&P Buy-Write Index ETN Info leaked?

Quote:
Originally Posted by CybrMike
Can someone explain the buy/write index?
Off hand, I think the gain may be so small that any expenses could wipe it out. IIRC, the history shows it to do slightly better than the S&P and with less volatility. But it does underperform in rapidly rising markets. Since, we've been through a rising market (or in the middle of one?), it might not be a bad time for this strategy.

Not hard to do yourself. Buy the ETF sell the call one strike out each month.

-KCMW

http://en.wikipedia.org/wiki/CBOE_S&P_500_BuyWrite_Index_(BXM)

http://cfe.cboe.com/Products/Products_BXM.aspx
Quote:
The CBOE S&P 500 BuyWrite Index (BXM) is a benchmark index designed to track the performance of a hypothetical buy-write strategy on the S&P 500 Index. Announced in April 2002, the BXM Index was developed by the CBOE in cooperation with Standard & Poor's. The BXM is a passive total return index based on (1) buying an S&P 500 stock index portfolio, and (2) "writing" (or selling) the near-term S&P 500 Index (SPXSM) "covered" call option, generally on the third Friday of each month. The SPX call written will have about one month remaining to expiration, with an exercise price just above the prevailing index level (i.e., slightly out of the money). The SPX call is held until expiration and cash settled, at which time a new one-month, near-the-money call is written.
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Re: S&P Buy-Write Index ETN Info leaked?
Old 05-21-2007, 12:31 PM   #4
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Re: S&P Buy-Write Index ETN Info leaked?

Quote:
Originally Posted by Olav23
I
Is this how most expense ratios are calculated?

on NAV mutual funds and ETFs yes it is

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Re: S&P Buy-Write Index ETN Info leaked?
Old 05-21-2007, 01:42 PM   #5
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Re: S&P Buy-Write Index ETN Info leaked?

I'm sorry, I should have explained what the BXM is. I was excited to hear about it, and got ahead of myself.
Like I said, I was waiting since a year ago for this to actually come to market.


From the BXM microsite: http://www.cboe.com/micro/bxm/introduction.aspx

Quote:
In 2006 Callan Associates, an investment services consulting firm, published a new study on the CBOE S&P 500 BuyWrite Index, with an analysis of performance from June 1988 through August 2006. Their study builds upon the earlier studies done by Professor Robert Whaley (now at Vanderbilt University) and by Ibbotson Associates. The new Callan Associates study had several key findings, including:

* BXM generated superior risk-adjusted returns over the last 18 years, generating a return comparable to that of the S&P 500 with approximately two-thirds of the risk. (The compound annual return of the BXM was 11.77% compared to 11.67% for the S&P 500, and BXM returns were generated with a standard deviation of 9.29%, two-thirds of the 13.89% volatility of the S&P 500.)
* The risk-adjusted performance, as measured by the monthly Stutzer Index over the 18-year period, was 0.20 for the BXM vs. 0.15 for the S&P 500. A comparison using the monthly Sharpe Ratio yielded similar results (0.22 vs. 0.16, respectively), confirming the relative efficiency of the BXM over the 219-month study period.
* The BXM underperformed the S&P 500 during most rising equity markets and consistently outperformed the S&P 500 in all periods of declining equity markets, demonstrating the return cushion provided by income from writing the calls.
* The BXM generates a return pattern different from that of the S&P 500, offering a source of potential diversification. The addition of the BXM to a diversified investor portfolio would have generated significant improvement in risk-adjusted performance over the past 18 years.
You could definitely implement this yourself, and could probably do it cheaper. But, like buying a fund vs doing it yourself, you have professionals doing the work for you. Also, they would deal with tracking error, etc.


Also, the fact that this is an ETN makes me think it could potentially be much more tax-advantaged over using a similar strategy yourself in a taxable account. ETNs do not make interest payments, and are supposedly treated as a prepaid contract, so you get long-term capital gain treatment when you sell it after a year (I believe). This is the same as the DJP Commodity tracking structure ETN. This structure could be challenged in the future though.
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Re: S&P Buy-Write Index ETN Info leaked?
Old 05-21-2007, 02:19 PM   #6
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Re: S&P Buy-Write Index ETN Info leaked?

Quote:
Originally Posted by Olav23

From the BXM microsite: http://www.cboe.com/micro/bxm/introduction.aspx

Quote:

(The compound annual return of the BXM was 11.77% compared to 11.67% for the S&P 500, and BXM returns were generated with a standard deviation of 9.29%, two-thirds of the 13.89% volatility of the S&P 500.)
You could definitely implement this yourself, and could probably do it cheaper.
From that report:
Quote:
Like many passive indexes, the BXM Index does not take into account significant factors such as transaction costs and taxes.
So, a 0.1% higher return will be offset by a 0.75% fee. Just holding the S&P ETF is a very low fee (~0.18% plus a buy/sell commission of a $XX.00. Doing this yourself would incur monthly transaction costs for the calls and any sell/repurchase, but those could still be fairly low on a sizable account with a discount broker. Taxes are a whole 'nother matter, but I would assume the fund would need to account for much of the gains as short term capital gains.

Someone else could probably chime in and tell us if a strategy of a blend of bonds and S&P would give similar results? Offhand, it seems that you would need a lot of bonds to drop the standard dev that much lower, and in turn, that would lower your total return?

I have to admit, that reduction in volatility is impressive, and little/none is lost in total return. Pretty neat 'trick'.!

OTOH, what exactly is lower variation worth? Certainly worth a lot if you need to cash in during a down period. But, if you have sufficient short term money to cover that, it almost seems like just a 'feel good' thing? For example, if you told me that 20 years from now, this 'bucket' in my account would be worth $x, would I really care that it wavered on the way there? Maybe re-balancing on those normal market dips/peaks would actually provide superior returns?

-ERD50





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Re: S&P Buy-Write Index ETN Info leaked?
Old 05-21-2007, 03:43 PM   #7
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Re: S&P Buy-Write Index ETN Info leaked?

Quote:
Originally Posted by ERD50
Someone else could probably chime in and tell us if a strategy of a blend of bonds and S&P would give similar results? Offhand, it seems that you would need a lot of bonds to drop the standard dev that much lower, and in turn, that would lower your total return?
This is true. In another thread we talked about the fact that a covered call had the same return pattern as a naked put. So, another way to implement this would be with a MM fund and short 1-month puts on the S&P 500 (I would use SPX's since they are cash-settled). Since the BXM is rolling one-month covered calls, one would want to hold short-term paper which matches the horizon of the buy-write.


Quote:
Originally Posted by ERD50
But it does underperform in rapidly rising markets.
Very true, and so far this year BXM is up 3.3%, while the S&P has had a total return of about 8.3%



I think that it is interesting to note that, according to the backtest, the reason that BXM outperformed the S&P 500 was due to the fact that the average implied volatility of the calls sold was higher (16.5%) than the subsequent realized volatility of the S&P 500 (14.9%). This difference accounts for an extra 0.2% of extra call premium per month (about 2.4% per year). IOW, had the implied volatility of the calls sold equaled the realized volatility, the BXM would have underperformed the S&P 500 by more than 2% per year. Of course, the expected return on a buy-write is less than that on the underlying stock.

Buy-Write = Stock - Call

Exp Rtn [Buy-Write] = Exp Rtn [Stock] - Exp Rtn [Call]

Since the expected return on the call is positive, the expected return on the buy-write is less than that on the stock.
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Re: S&P Buy-Write Index ETN Info leaked?
Old 05-21-2007, 04:17 PM   #8
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Re: S&P Buy-Write Index ETN Info leaked?

Very interesting, FIRE'd.

Since it sounds like you have dealt with options a lot more than me, how often is the case where implied volatility is higher than the realized volatility? Is this generally the case? Or does it happen when volatility is picking up and people get overly anxious, thereby overshooting the implied volatility? Is this a usual occurence or some data-mining/cherry picking that occured over the past 20 years? I guess my question is, is it statistically significant or more of something that averages itself out over time?
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Re: S&P Buy-Write Index ETN Info leaked?
Old 05-21-2007, 05:04 PM   #9
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Re: S&P Buy-Write Index ETN Info leaked?

Quote:
Originally Posted by Olav23
Since it sounds like you have dealt with options a lot more than me, how often is the case where implied volatility is higher than the realized volatility? Is this generally the case? Or does it happen when volatility is picking up and people get overly anxious, thereby overshooting the implied volatility? Is this a usual occurence or some data-mining/cherry picking that occured over the past 20 years? I guess my question is, is it statistically significant or more of something that averages itself out over time?
Very good questions. My guess is that it will average out over time, and that market makers will underestimate future volatility as often as they overestimate it. As you know, volatility is impossible to predict. I think there are overshoots at times due to fear. People who sell volatility just after an event like the 1987 crash make a lot of money. However, implied volatilities were very high just before the 1987 crash, and many people sold volatility then only to blow themselves up. After 1987, options sellers were able to command (and option buyers willing to pay) higher premiums (implied volatilities). The point of my post was to point out that this was the source of the BXM outperformance. Whether this bias will exist in the future is anybody's guess. Theoretically, on the basis of expected return arguments, one would expect BXM to underperform the S&P 500.
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Re: S&P Buy-Write Index ETN Info leaked?
Old 05-21-2007, 05:30 PM   #10
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Re: S&P Buy-Write Index ETN Info leaked?

Why can't an individual investor do this by purchasing an ETF like IVV or SPY and writing a covered call on the position. A .75% ER seems like a pretty expensive way to implement a pretty simple strategy.
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Old 05-24-2007, 05:16 PM   #11
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So, it did come out today as expected. All sorts of glossy charts on the webpage if anyone is interested:

iPath ETNs - CBOE S&P 500 BuyWrite Index ETN - Returns & Risk Analysis

First day of trading was quite light at only 4,100 shares changing hands.
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