Sometimes it takes years for trail-blazing academic research to have its full effect on portfolio strategies.
Such is the case with Robert Whaley, professor of management at Vanderbilt University's Owen Graduate School of Management, Nashville, Tenn., who has written pioneering studies starting in the 1990s on how to protect portfolios against surging volatility.
Mr. Whaley also has helped to create some of these hedging instruments, including options and futures contracts based on the Chicago Board Options Exchange's market volatility index (VIX), the Nasdaq market volatility index (VXN) and the BuyWrite monthly index (BXM). He described the VIX contract in a 1993 Journal of Derivatives article.
His work on the risk/return of strategies based on the CBOE BuyWrite monthly index — being long stocks and short call options on the same equities — is seen by an increasing number of portfolio managers as relevant in today's volatile markets.
“BuyWrite strategies work best in this particular environment because, when volatility goes up, people are prepared to pay more for insurance, even extreme premiums. So, if you write the insurance and the market does not move as much as feared, you get the insurance premium and enhanced return on your portfolio,” Mr. Whaley said.
These once-exotic strategies have simple applications as well to capture added returns. Last summer, Mr. Whaley published “Failure to Exercise Call Options: An Anomaly and a Trading Game,” which showed that investors failed to capture $491 million over a 10-year period by not exercising options prior to ex-dividend dates.
The paper was written with Hans Stoll — who serves as co-director of Vanderbilt's Financial Markets Research Center along with Mr. Whaley — and Veronika Krepely Pool, assistant professor in finance at Indiana University, Bloomington, Ind.
“The S&P 500 index was down 9.4% in the first quarter. Those kinds of declines are significant, but it is possible to reduce their impact on a portfolio through the use of index options contracts,” said Walter Sall, chairman of Gateway Advisers LP, Cincinnati, with $8 billion in asset under management. Gateway is a subsidiary of Natixis Global Asset Management, Paris, with $869 billion in assets under management.
“The traditional investment community is becoming more educated and sophisticated in the use of all those different derivatives tools in order to improve the risk/reward efficiency in their portfolios,” Mr. Sall said. “Many more investors use these tools to reduce the risk profile of their equity portfolios.”—Isabelle Clary
