Buy-Write in Rising Rate and Market Downturn Environments

Kim Arthur, CIO/CEO, Main Management

Rates at Historic Lows, and Increasing

The Fed funds rate has been at all time lows in recent years and a number of developed countries have found it necessary to enforce negative interest rates in order to spur growth. Since rates are expected to rise going forward, we looked at some of the recent historical rising rate environments (see Figure 1) to see how Buy-Write strategies performed.

Rising Rate Performance Comparison Chart - S&P 500, Barclays Agg, Option Writing

How has Buy-Write performed in a Rising Rate Environment?

In Figure 1, we take a closer look at three instances of rising rate environments in the past. For these data points, Buy-Write strategies (represented by the BXM benchmark and Morningstar Option Writing Category) historically outperformed fixed income (represented by the Barclays US Aggregate Bond index). In addition, it was observed that fixed income typically experienced negative returns during a rising rate environment.

What about Market Downturns?

Rising rates have the potential to lead to market downturns, especially if the rate hike takes the market by surprise like it did in 1994. The first downturn in Figure 2 in 1994 corresponds to the first rising rate environment in Figure 1. We are currently experiencing one of the largest bull markets in history, and are potentially due for a pullback which might evolve into a market downturn. In this type of environment, Buy-Write strategies may reduce volatility.

Major Market Downturn Performance - S&P 500, BuyWrite, Option Writing

Averaged among the three events in Figure 2, Buy-Write strategies showed 44% less downside than equity markets (represented by the S&P 500). If the Federal Reserve’s continued tightening triggers a market correction, a Buy-Write strategy may be an appealing option to both enhance your portfolio as well as to cushion it from potential downsides.

Main Management has been running a BuyWrite strategy for over a decade, and as a boutique investment manager, we’re happy to speak with you, offer additional resources, and answer any questions. To learn more about our BuyWrite strategy, watch the strategy video here.

The information contained herein was prepared using sources that Main Management believes are reliable, but Main Management does not guarantee its accuracy. The information reflects subjective judgments, assumptions and Main Management’s opinion on the date made and may change without notice. Main Management is not obligated to update this information. All equity investing entails risk of loss. Past performance is no guarantee of future results. All investment involves risk, including possible loss of investment. Many securities transactions are risky and are not suitable for all investors. All securities investments carry risk, including a risk of loss of principal.

CBOE S&P 500 BuyWrite Index (BXM) is a benchmark index designed to track the performance of a hypothetical buy-write strategy on the S&P 500 Index.

Barclays US Aggregate Bond index covers the USD-denominated, investment-grade, fixed-rate, taxable bond market of SEC-registered securities.

Morningstar Option Writing Category includes funds which aim to generate a significant portion of their returns from the collection of premiums on options contracts sold.