Systematic Call Buying on the Nasdaq-100 Index

Investors could be overlooking the positive effects of inflation and rising rates:

• An overlooked concept during inflationary periods is that stocks often benefit-- due to operating leverage when companies see margin expansion and increased profits from scalable business models and price increases.
• The ramifications of pent-up demand following the economy reopening after multiple years of a stay-at-home lifestyle are difficult to quantify and should be considered as offsetting some of the effects of rising prices. There will ultimately be winners and losers as this dynamic plays out over time.
• With the Fed dot plot now showing continuous rate hikes in the coming years and indicating they could be more aggressive than they have previously indicated, we wonder whether the 40-year bond bull market is ending and could precipitate what investors have deemed “The Great Rotation” – an exodus of assets out of fixed income and into equities.

Systematic Call Buying for Upside Convexity:

• Using a budgeted approach to buy calls on the Nasdaq-100 can often prove more efficient than a long only strategy in rising markets.
• The Nasdaq-100 Upside Convexity Strategy was designed using Volos’ Strategy Engine – a no-code web application that allows investors to develop and analyze custom single and multi-leg options

Findings:

• While performance of the Nasdaq-100 Upside Convexity Strategy has lagged the long-only Nasdaq-100 strategy since January 2007, it had a significantly lower Max Drawdown during the Financial Crisis.
• Since January 2018, the Upside Convexity strategy has high performance with strong periods of outperformance against both the long-only strategy and an at-the-money call buying strategy during sharp market rises.
• The Upside Convexity strategy significantly reduced Max Drawdowns versus the long-only strategy during the COVID-induced correction.

Detailed Findings:

• The Nasdaq-100 Upside Convexity Strategy has shown strong performance with the model portfolio having 4% annualized returns since January of 2007. The Upside Convexity Strategy had a max drawdown of 30.2% during financial crisis versus the Nasdaq-100 falling 53.4%.
• The Upside Convexity strategy has had significantly higher performance since January 2018 (21.3% annualized returns versus the ATM Call Buying Strategy’s 1%) and illustrates the benefits of spending a small portion of the budget to purchase out-of-the-money calls.
• The Nasdaq-100 Upside Convexity Strategy outperformed the Nasdaq-100 during the COVID-induced correction by roughly 980 basis point falling 18.2% versus the Nasdaq-100 falling 28%.
• Investors could preserve gains and employ active management to the Upside Convexity Strategy by monetizing call options when the Nasdaq-100 has risen significantly in a short period of time.

Study Rules:

The Nasdaq-100 Upside Convexity Strategy allocates a defined budget as a percentage of the historical hypothetical portfolio value to purchase 3-month NDX call options at each roll date. The strategy is governed by the following rules:

• 2% budget to purchase at-the-money call
• 5% budget to purchase 2.5% out-of-the-money call options.
• 5% budget to at-purchase 7.5% out-of-the-money call options.
• Uses two identical tranches each staggered by one-month to reduce path dependency (8% total budget at any given time with 4% in each tranche).
• Options are rolled with one month left to expiration to simulate early monetization and to reduce the annual spend of the call buying program.
• Has a benchmark of both the Nasdaq-100® and a two-tranche systematic call buying strategy that spends 4% per tranche purchasing 3-month at-the-money NDX call options.

Benefits of Systematic Call Buying:

Capital efficiency

• The strategy never invests more than 8% (2 tranches each with a 4% budget) of the portfolio value at any given time unless the calls appreciate in value.

Downside protection and reduced volatility during negative tail events

• An investor can never lose more than the initial purchase price of the existing call options positions at any given time.

Upside Convexity

• The strategy outperforms the Nasdaq-100 and the Nasdaq-100 3-month ATM Call Buying strategy in periods where the market appreciates significantly in value over a short period of time.
• We note that the Upside Convexity Strategy will have higher volatility and max drawdowns versus an ATM Call Buying Strategy but view the trade-offs as warranted for investors looking to generate strong outperformance when markets rise quickly.

Access the Nasdaq-100 Upside Convexity Strategy on NDX Connect a strategy marketplace for in-depth analysis on a wide variety of Nasdaq-100 index options model portfolios. Please visit www.ndxconnect.com.

Historical and simulated index performance is not necessarily indicative of future results. The information provided in this document does not constitute investment advice. Volos is not an investment advisor. Volos and its affiliates accept no © Volos Portfolio Solutions, Inc. 2022 responsibility whatsoever for any loss or damage of any kind arising out of the use of any part of the company products or the information contained therein.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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