Against the backdrop of both equity and fixed income markets having significant drawdowns in 2022, 2023 saw numerous options-based ETF solutions come to market with the objective of minimizing volatility or generating additional income through their investment strategies. With the increasing adoption of options-based investment solutions, the role that index providers have within this ecosystem is foundational in nature. Cboe Global Indices is the leading derivatives-based index provider in the world, with the capabilities necessary to realize complex index concepts backed by the largest pool of derivatives data and supplemented with proprietary pricing algorithms. In speaking with Berlinda Liu, Senior Director, Index Product Strategy at Cboe Global Indices, the history of the firm’s influence and ongoing innovation within the realm of indices creation was the focus of our conversation.
Pioneering Derivatives: Cboe Global Indices' Historical Journey
“As the first U.S. options exchange and creator of U.S. listed options, Cboe’s leading position in the derivatives market is our biggest strength in index product development. We have been publishing option-based indices for decades and have the most robust exchange-traded options data and the ability to price flexible exchange options, or FLEX options. The genesis of Cboe’s indices business began in 1993 with our creation of the Cboe Volatility Index (VIX) – the world’s first volatility index and a groundbreaking innovation that has since led to over a quarter-century of innovation. At the time of its launch, the VIX Index not only offered a completely new way for market participants to measure, and trade expected future (30-day forward) U.S. equity market volatility, but also laid the foundation for Cboe to develop a wide array of volatility products, including futures and options based on the VIX Index itself.” said Ms. Liu.
Presently, Cboe Global Indices has over 450 derivative-based indices covering a wide range of asset classes and strategies, including benchmarks for volatility, options strategies, equity sectors and more. As stated by Ms. Liu, the impetus behind the creation of an index can arise from both internal and external sources. “Cboe actively engages with various market participants and academia to identify gaps in the market and introduce innovative investment instruments. The idea for the first volatility index was initially proposed in an academic paper by Brenner and Galai published in 1989, then in 1993 Cboe collaborated with Professor Robert E. Whaley, a professor and expert in derivatives valuation and risk management, to launch the VIX Index. Ten years later, working with Goldman Sachs (NYSE:GS), Cboe further enhanced the VIX methodology to capture broad equity market volatility.” said Ms. Liu. More recently, Cboe has brought to the market a series of buffer protection indices, as stated by Ms. Liu, their creation stems from the collaboration between various stakeholders, “For decades, buffer protect strategies have been accessible only to institutional investors and certain insurance products via structured products offered by investment banks. In 2016, Cboe collaborated with S&P Dow Jones Indices, Innovator ETFs, and Milliman to launch the Cboe S&P 500 Buffer Protect Indices, the first suite of Buffer Protect Indices in the world. These indices provide a transparent systematic measurement of buffer protect strategies and serve as the underlying benchmark indices, for which a growing number of defined outcome ETFs are based on.”
Ascendance of Options-Based ETF Strategies
The growth of options-based ETF strategies has been a noticeable trend in recent years. In the U.S. over 40 new buffer ETFs were launched in 2023, whereas Canadian options-based ETFs amassed $19.8 billion in assets under management (AUM), across 166 products in the same year. Generally speaking, options-based strategies fall into two thematic groupings, income generation and risk management. In the case of the former, option-selling strategies, such as covered call (or buy-write) and cash-secured put write, provide a valuable income stream that generally has a low correlation to the equity market. Regarding the latter, buffer ETFs offer a predefined risk-reward profile, in that investors know upfront the range within which the fund's returns are expected to fall. This transparency can be attractive to investors who want to manage their risk exposure more precisely and have a clearer understanding of potential outcomes. With Cboe derivative-based indices being the benchmark for many option-based ETFs currently in the market, Ms. Liu shared this insight, “Structured products investment vehicles have used buffer protect strategies for decades. Since 2016, dozens of Cboe Buffer Protect Indices have been introduced to help make buffer protect strategies more transparent and widely available. Cboe Buffer Protect Indices improve return consistency and reduce downside risk from long exposure to the reference asset. A recent paper by Professor Oleg Bondarenko and Dmitriy Muravyev shows that the Cboe Buffer Protect Indices have less severe maximum drawdowns than the underlying indices. The S&P 500 dropped by 51% at its bottom during the financial crisis, but the Cboe S&P 500 Buffer Protect Index Balanced Series only dropped by 39%. The drawdown reduction is about equal to the 10% buffer level.”
In recent years, the elevated level of market volatility that has been present has allowed Cboe Global Indices to showcase the breadth of their indices offerings and their ability to manage market volatility effectively. In speaking about the efficacy of their indices offering, Ms. Liu stated, “Options and VIX derivatives, by design, offer asymmetric return outcomes and can be used to hedge downside risk. One example is the Cboe VIX Tail Hedge Index that has a built-in hedge with VIX options. It went up 141% in the past five years ending December 2023. It offers an equity exposure at a reduced correlation. The Cboe Capped VIX Premium Strategy Index returned 153% in the past five years. This VIX strategy may be considered as a diversification tool to an equity portfolio.” As market events continue to shape and shift the investment landscape, the traditional 60-40 portfolio that benefitted investors in the past, may not garner similar success in the present or future. As such, investors increasingly are pivoting towards option-based solutions that may leverage and reflect the investment engineering of Cboe Global Indices.
Innovative Horizons
As a future-focused firm, Cboe Global Indices continually seeks to identify innovative offerings that they can bring to market for the benefit of their clients. Last year the firm launched the 1-Day Volatility Index (VIX1D) designed to measure the expected volatility of the S&P 500 Index over the current trading day, which employs a similar methodology to its well-established counterpart the VIX Index. However, the VIX1D Index focuses on the compressed measurement of volatility over a single day, accounting for the short-term impact of news events on the market. In speaking with Ms. Liu about any recent or upcoming indices offering, she stated, “We are excited about the new Cboe S&P 500 Dispersion Index (DSPX). It measures the expected dispersion in the S&P 500® over the next 30 calendar days, as calculated from the prices of S&P 500 index options and the prices of single stock options of selected S&P 500 constituents. The index may provide an indication of the market's perception of the near-term opportunity set for diversification or, equivalently, as an indication of the market's perception of the near-term intensity of idiosyncratic risk in the S&P 500's constituents.” While the top-of-mind focus for many investors is equity investing, Cboe Global Indices also has indices offerings centering on other asset classes. Regarding new offering centering on other asset classes, Ms. Liu stated” In fourth quarter of 2023, we also began publishing four new Credit Volatility Indices (Credit VIX), which are based on our proprietary VIX Index methodology and S&P Dow Jones Indices' CDX and iTraxx Indices. Just as the VIX Index aims to reflect investors' view of future expected U.S. stock market volatility, the new Credit VIX Indices are designed to provide an equivalent measure for the U.S. and European credit markets.”
As the world's go-to derivatives and exchange network, Cboe Global Indices continues to fulfil their mission of building a trusted, inclusive global marketplace that enables people to pursue a sustainable financial future. The ongoing innovation the firm continues to exhibit is reflected in the conceptualization and creation of the indices that they bring to market.
This content was originally published by our partners at the Canadian ETF Marketplace.