A Way to Smooth the Market Volatility Ride

If we focus our attention inside the tails of these distributions, we see further the value of a covered call writing strategy during normal markets.  Since the BXM Index inception, 71% of monthly returns have been between -4% and +4%.  During these months, the BXM has captured 119% of the return of the S&P 500. 

The BXM's long-term upside capture of 64% vs. 72% on the downside is not particularly desirable at first glance. But taken in the context of the return capture of the past 12 months that we highlighted at the onset (19% of S&P since 9/30/13), this balance is understandable. Of course, the stated strategy of the BXM is to cut off some of the upside by writing at-the-money calls on the SPY each month. 

Another way of demonstrating the value of owning BXM-like volatility is during the most extreme environments in the equity markets. The following chart from the CBOE depicts several of the most volatile periods in the market over the past 20-plus years. Please note this return period extends the BXM Index to years prior to its official published date using the same methodology that currently exists of rolling monthly covered call options.

What stands out is the protection the BXM provides during down markets. Just as appealing however, is that in strong up markets the index generally keeps pace with the S&P 500. 

So where does this leave the equity investor that has made roughly 20% thus far in 2013? Again, with the macro headlines today and the lack of compelling alternatives on the traditional side (fixed income, cash), the advantages of an equity substitute with a structural objective to reduce volatility could make sense. 

As investors continue to seek daily-liquid assets that are less correlated and/or hedged, the BXM and strategies focused on delivering similar return characteristics may begin to draw investor attention.