While options industry executives said the strategy is not new, two developments have given it more credibility.
First, in 2002, the Chicago Board Options Exchange created a buy-write index based on the S&P 500, the CBOE S&P 500 Buy Write index, or BXM. The index tracks the performance of a hypothetical buy-write strategy on the S&P 500.
Second, and possibly more important for institutional investors, Ibbotson Associates, Chicago, released a report in September based on a case study of the investment value of the BXM from a total portfolio perspective. The results showed that over a 16-year period, from June 1988 through March 2004, the compound-annual return of the BXM was 12.39%, compared with 12.2% for the S&P 500, with about two-thirds the volatility. In addition, the study found the BXM strategy outperformed the Russell 2000 and Morgan Stanley Capital International Europe Australasia Far East indexes.
Despite the outperformance over the period, the strategy severely underperformed from the mid-1990s through the top of the bull stock market in 2000. According to the Ibbotson report, however, one dollar invested in the BXM strategy on June 1, 1998, would have grown to $6.36 by March 31, 2004, while a dollar invested in the S&P 500 index would have reached $6.19 over the same period.
"The frequency of calls requesting information has been going up more steadily since last fall, and that's been precipitated to a large extent by the publication of Ibbotson's white paper," Rampart's Mr. Egalka said.
Brian Duffy, treasurer of SKF USA, Trooper, Pa., and responsible for the firm's $600 million pension plan, started using a buy-write strategy using S&P 500 options on a portion of the fund's 70% equities allocation in mid-2004. "It's really an enhancement" to the portfolio, not a core strategy, he said.
Mr. Egalka — an early adopter of the BXM strategy, whose firm was the first money manager licensed to offer investment products based on the BXM— said he has recently made presentations to executives at some large pension funds, but declined to provide further details.
TD Securities' Mr. Rahbari noted that for some plan sponsors and boards of trustees, derivatives is a dirty word because some of the biggest financial scandals and debacles have been linked to the use of derivative instruments.
In addition, covered call writing went out of style in the mid-1990s, when the stock market rallied and some investors got caught with positions that lost a lot of money.
"A lot of people were doing it on an overlay basis and didn't have the underlying" securities, said Joanne M. Hill, managing director of equity derivatives strategy at Goldman Sachs & Co., New York. "When there was a big upside move in a short period, there was a lot of cash people had to come up with. People were doing it maybe more as an income strategy than as a lower-risk equity strategy, and it went into the backwater."
Some firms that offered covered call strategies in the mid- to late-1980s left the business after being "beaten to a pulp" as the stock market began its historic bull market climb, according to one pension plan consultant.
But in today's low-return environment, the strategy is getting more attention, particularly with an index that allows the strategy to be tracked.
Keith A. Styrcula, chairman of the Structured Products Association, New York, called the BXM strategy "tailor made" for pension plans.
BXM "is a highly efficient way for pension plans to capture additional alpha without the friction of management fees," he said.
Still, he said, despite some compelling back-tested performance data on the BXM, plan sponsors, consultants and portfolio managers often want to see real-time performance over a year before adopting the strategy.
Walter V. Haslett, president and chief investment officer of Write Capital Management LLC, Mount Laurel, N.J., which specializes in options strategies including covered call writing, said some investors run into difficulty with the strategy because they do not understand the cost.
"Covered call writing is not a free lunch," he said. "If you overwrite 40% of your equity portfolio and the market is unchanged, down or up slightly, that 40% is going to outperform. It's going to allow you to have better returns that will help you make payouts if you're a pension fund," he said. "But if the stock market rises, like it did in the fourth quarter of last year, that 40% is going to underperform. But the other 60% is going to rise with the market."
Mr. Rahbari added: "This isn't the holy grail. It's another option for people to try to control the risk-return reward in their portfolio, to add a little alpha."
He said the strategy can be particularly useful for larger institutions that can customize their own over-the-counter options. "If you are a really big institution, you can pick any (option expiration) date you want and any strike price you want," he said. "The reason big institutions like OTC options is because of the flexibility."
Listed options have set expiration dates and strike prices.