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BuyWrite Index (BXM)

June 2005

The CBOE S&P 500 BuyWrite Index (BXM) is an index designed to measure how well a covered call writing strategy performs when compared with a buy and hold strategy on the identical portfolio. The index was first introduced in April 2002, but to provide an historical perspective, data was calculated back to June 1, 1988.
Trading Methodology
The hypothetical stock portfolio consists of all the stocks in the S&P 500 Index, each in its appropriate proportion. The option sold is an SPX option (SPX is the symbol for the S&P 500 index options). The option is sold in the morning on the 3rd Friday of the month. The option chosen always expires in the front (nearest to expiration) month and has a strike price that is nearest to (but above) the actual price of the underlying index.
Example:
On Friday Jun 17, if the index is 1204.63, the Jul 1205 call option is sold. The option is held until it expires and no adjustments are made. If the option expires out of the money, it is worthless and a new call option is written as described above. If the option expires in the money, then it is 'cash settled.' That means the option's intrinsic value is removed from the option writer's account (and transferred to the account of an option owner). A new call option is written as above. Note: no securities change hands when expiration arrives. Options are settled in cash, not in shares.
Example:
On Friday, Jul 15, the settlement price for the SPX is determined to be 1207.52. The option is in the money by 2.52 points [the difference between the strike price (1205) and the index value (1207.52)]. Thus, $252 is delivered to the option owner. Note: The net result is equivalent to selling the bundle of stocks at the strike price of $1205, but cash settlement is an easier method of transferring assets when compared with the traditional assignment method of transferring shares of the underlying security.
Settlement Price
SPX options expire at the opening of the market on the 3rd Friday of the month (equity options expire at the close of business on the same day). The settlement price of the index is not determined by the price of the actual index at any one time. Instead, the settlement price is calculated from the opening price of each individual component of the index.
Performance
From Jun 1988 through year-end 2004, BXM provided an annualized return of 12.2% compared with 12.1% for the S&P 500 index. But the major edge for buy-writers is the reduced volatility. The standard deviation of the annual returns was 33% lower for followers of the buy-write methodology. That means portfolio valuation fluctuated less - the average yearly change in the value of the portfolio was one third less than that of the unhedged portfolio. BXM outperforms buy and hold during most markets - underperforming only when the market surges higher. Coupled with reduced portfolio volatility, that makes covered call writing a very attractive strategy going forward.

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