Stoxx, a leading index provider, has introduced the Euro Stoxx 50 BuyWrite 100% Index. The index measures the performance of a buy-write or covered-call strategy based on the Euro Stoxx 50 Index, the eurozone’s leading blue-chip equity index.

Hartmut Graf, Chief Executive Officer of Stoxx.

The new index, which has been designed to underlie index-linked financial products such as exchange-traded funds (ETFs), represents a hypothetical portfolio of a long position in the Euro Stoxx 50 and a sold – or written – call option based on the same index.

The index follows the methodology of the existing Euro Stoxx 50 BuyWrite Index, which was introduced in September 2006; however, the strike price for the option is set to 100% instead of 105% as in the existing index.

The adjustment from 105% to 100% means that the call option is written at the money (i.e. the option with the highest strike price below or equal to the Euro Stoxx 50 settlement level) instead of 5% out of the money.

In effect, the adjustment reduces the upside potential but increases the downside protection as the option premium (in part a function of volatility, time and strike price) is greater as the option is written at the money. Variations of this strategy include writing deep in-the-money options to exploit the decay-of-time premium.

The mechanics of the index are such that the Euro Stoxx 50 Index and a Euro Stoxx 50 call option are held in equal amounts and adjusted on a monthly basis. Every month a new one-month Euro Stoxx 50 call option replaces the previous expiring Euro Stoxx 50 call option. The new option must have a remaining lifetime of one month and be at the money.

This kind of strategy, which can be applied to any equity index with tradable options, tends to outperform a conventional long-only position in a corresponding plain vanilla index during market downturns, with the option premiums serving as a downside buffer. However, the strategy typically underperforms in bull markets, with the written call option capping upside potential, essentially acting as a drag on performance.

The strategy also has lower volatility compared to the corresponding plain-vanilla index, owing to the option premiums offsetting market falls, while at the same time stunting market rallies. The strategy’s main weakness is this latter issue: the limited upside participation it offers.

The Euro Stoxx 50 index is one of the most widely followed equity benchmarks, covering 50 large-cap stocks from 12 Eurozone countries: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain. Options based on the index are among the world’s most actively traded.

Hartmut Graf, chief executive officer of Stoxx, said: “The Euro Stoxx 50 index options achieved 280 million traded contracts at the end of 2012, which makes them the world’s third largest traded index options after the Kospi 200 Options and S&P CNX Nifty Index. The high liquidity of these options enables us to further expand our strategy index series based on options prices with the launch of the Euro Stoxx 50 50 BuyWrite 100% Index.”

The existing Euro Stoxx 50 BuyWrite Index already underlies an ETF, namely the Lyxor ETF Euro Stoxx 50 BuyWrite (BWE), listed on the NYSE Euronext Paris. This new index will likely be pitched to ETF providers, too, as well as issuers of structured products. It will appeal to investors seeking alternative sources of income.

There are a number of other buy-write or covered-call strategy exchange-traded products out there already, including the German DAX-based  Lyxor ETF DAXplus Covered Call (CCD) listed on the NYSE Euronext, Deutsche Borse and Borsa Italiana, the PowerShares S&P 500 BuyWrite Portfolio ETF (PBP) and iPath CBOE S&P 500 BuyWrite Index ETN (BWV) based on the S&P 500 Index, and the actively managed global AdvisorShares STAR Global Buy-Write ETF (VEGA), all listed on the NYSE Arca. For Canadian investors, BMO and Horizons offer a range of innovative products in this space.

Innovation in this area continues apace, driven largely by low interest rates and investors’ desire for income. Notable recent developments include two exchange-traded notes (ETNs) issued by Credit Suisse based on covered call strategies on gold and silver ETFs: the Credit Suisse Gold Shares Covered Call ETN (GLDI) and Credit Suisse Silver Shares Covered Call ETN (SLVO) respectively.