CBOE Paper: Rebalancing Using Options

CBOE and SIGLO Capital Advisors published a paper on rebalancing using options which is based on AlgoTrader. 

Abstract: In this paper, we describe different ways to rebalance the strategic asset allocation in a multi-asset class portfolio by writing call and put options on the S&P 500 index. Based on our practical observation, we assume that institutional investors define a strategic asset allocation for their portfolios and aim to hold their exposures per asset class more or less constant over time, i.e. within an upper and a lower boundary for each asset class. In case of significant price moves across asset classes, a rebalancing of the portfolio is needed in order to remain within the predefined strategic boundaries. Instead of simply watching price movements and discretionarily deciding about potential rebalancings, we show how simple option-writing strategies can add value over time by capturing the option premium while systematizing an efficient rebalancing process.

We acknowledge that describing a positive expected return from option-writing strategies is not new to financial market research and we are aware that investors already write options to enhance returns. However, the context of applying option-writing strategies to rebalance the strategic asset allocation of institutional investors has received scarce attention and to our knowledge has not been tested on historical time series. Our research provides a set of back-tested performances for a typical institutional multi-asset class portfolio and for a variety of rebalancing scenarios using options as its primary rebalancing tool. In our observation period beginning January 1997 to the end of 2013, we can add up to 50 basis points per annum on the total portfolio return compared to a buy-and-hold approach without significantly increasing the risks.

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