Put-write differs from buy-write options, which have been used by pension funds for several years, because of what underlies either option, said Reid Hellekson, senior implementation portfolio manager at Russell in Seattle.
“They're very similar,” Mr. Hellekson said. “Buy-writes have equity holdings underlying the option; put-write has cash underlying the security. Because of this, you get more liquidity from put-write. People use put-write as an equity overlay, replacing their beta one overlay (hedge) with puts.”
The put-write strategy serves both as protection against downside risk and volatility but has the added bonus of providing income, said Frank Tirado, vice president of education, Options Industry Council, Chicago. “This is a strategy that generates income. It does also reduce risk,” Mr. Tirado said.
There's also the advantages of using put-write equity options for both their transparency, because they're traded on exchanges, and for their liquidity, added Matt Moran, vice president, business development, Chicago Board Options Exchange, Chicago. Such options “can be part of a risk-parity strategy and part of a (liability-driven investing) strategy,” as well as an income producer, Mr. Moran said.
The downside of put-write options is if a stock falls below the strike price by expiration, the stock would have to be bought at the original strike price, not at the lower price, and would reflect a loss.
Consultants are starting to take notice, said Mr. Moran, with five of the top 10 firms in terms of assets under advisement writing research papers on put-write options, including the latest issued last month by Wilshire Associates. In its paper, Wilshire noted that the CBOE S&P 500 put-write index, with an annualized 10.1% return, outperformed the CBOE S&P 500 buy-write index's 8.9% and the S&P 500 stock index's 9.9% over 30 years ended Dec. 31. And for 2015 alone, the put-write index returned 6.4% vs. the buy-write index's 5.2% and the S&P 500's 1.4%.
“2016 will be a big year for put-write hiring in terms of RFPs issued and their allocations,” Mr. Moran said.
Mr. Tirado said put-write options are becoming popular with pension funds at a time when their overall equity portfolio can be too risky and their bond portfolio isn't providing enough income in a continuing low-rate environment.
“Pension funds are between a rock and a hard place,” Mr. Tirado said. “Low funding, risky assets, both have exposure to downside risk. In this, they've constructed a strategy to transfer risk.”
Added Mr. Moran: “If stuff does hit the fan and the bubble bursts in bonds — and maybe even equities — there could be even more of a move toward lots of alternative instruments like this, especially when plan trustees start asking their consultants, "Why didn't you tell us about this?'”
Also, a sense of a new normal ahead with low rates and low equity returns has driven interest in the strategy, said Mr. Tirado. “Something like this has never happened before,” he said. “You hold and hope things get better, and with stocks, it has. But what's new is the interest rate situation. Everyone's waited and waited and waited, but it's just not happening. This is new. They don't teach you how to handle negative interest rates when you're in college. Everything is somehow priced to rates, but what if those rates are negative?”