Luring New Customers Into The Options Market Using SPX Buy-Writes
...continued from "An Easier Way To Trade Buy-Writes"
The options industry continues to set new trading records every year.Unfortunately, despite this explosion in volume, many financialprofessionals remain skeptical of the options markets.
This is particularly true when it comes to financial advisers andplanners. For these skeptics, the notion of using options inconjunction with their clientsí equity portfolios remains a dauntingprospect. The options industry has spent millions of dollars developingproprietary products to lure reticent professionals into the fold.Unfortunately, few of these products have managed to withstand the testof time.
Some of these products simply vanished into obscurity. Others failed to garnerenough volume to merit serious attention. Once in a great while,though, a product comes along that is inventive enough to survive theperilous options world.
One such product is the BuyWrite Index (BXM).Launched with little fanfare in 2002, the BuyWrite product line hasslowly managed to carve out a unique niche in the options world.
The BuyWrite Index faced a number of hurdles when it was launched. Notthe least of these hurdles was its name. Although buy-write is a common termamong option traders, few outside the industry have ever heard of it.Instead, they refer to the strategy of buying an underlying securityand writing a call against it as a ìcovered call.î
When the BuyWrite Index was created in 2001, covered calls had a badreputation in the equity world. Many traders still had bittermemories of the 1990ís when their covered callstrategies underperformed the rampaging bull market.
As a result,the CBOE had to cloak their covered call index with the archaic nameBuyWrite Index just to give it a fighting chance with its target market.
HOW IT WORKS
Although the name BuyWrite Index remains terrifying to many investors,the underlying mechanics of the product are quite simple. The BXMreplicates the return of owning the underlying S&P 500 index andwriting calls against it.
ìThe strategy is essentially selling thefront month at-the-money calls,î says CBOE Executive Vice Chairman EdTilly. ìFor the purposes of the BXM, it would be owning the S&P 500index and selling the front month at-the-money calls in the SPX.î
While many hedge funds and portfolio managers write calls against theirstocks, they usually only do so about once a quarter or once a year.However, the BXM writes calls against the S&P 500 every month.
Thisincreased frequency was chosen for two reasons. The first reason is tocapture the higher level of time decay that comes from writingshort-term options as opposed to longer-term options.
ìMost people who write calls against their portfolios choose to writelonger dated, out of the money options. But we decided to go with onemonth at-the-money, or slightly out of the money, calls,î says MattMoran, Vice President of Business Development for CBOE. ìThe reason isthat, if you write twelve 1-month options, then you should collectnearly twice as much time decay as if you wrote four 3-month options.î
The second reason for writing calls every month has to do with theendless war for volume in the options markets. With six exchangesbattling tooth and claw for the title of ìworldís largest optionsexchange,î every single contract is vital.
Since the BXM requireslicensees to roll SPX positions every month, it is helping to generateadditional volume and increased revenue in one of the industry'ssignature products.
To Be Continued in Part 2...
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