Stabilizing Returns With Derivatives

September 30, 2002


Since U.S. stock indexes have fallen from their all-time highs in early 2000, many institutional investors have searched for investment tools and vehicles that can help them better diversify their portfolios and manage their risks and costs. Indeed, the Employee Retirement Income Security Act (ERISA) generally requires corporate pension fiduciaries to diversify the investments of the plan to minimize the risk of large losses, except when it is clearly prudent not to do so.

Index options and futures are tools that for two decades have been used to help diversify portfolios and lessen systematic risks and trading costs. This paper will provide an overview of two benchmark indexes designed to show long-term returns of strategies based on index options or futures trading the CBOE BuyWrite Monthly IndexSM (BXM) and the Goldman Sachs Commodity Index (GSCI). Both of these total return indexes could be helpful tools to institutional investors trying to meet their fiduciary obligations. For example, some institutional investors might appreciate the fact that, in the period from June 1988 through July 2002, GSCI had a slightly negative correlation of monthly price changes with the S&P 500, while the BXM Index had a relatively low standard deviation of monthly changes.

One initial caveat for readers: This paper is written primarily for tax-exempt institutional investors who plan to use a portfolio manager experienced in options or futures. Taxes, margin and transaction costs generally are not taken into account in the reporting of index returns, but these factors can have a major impact on the returns of inexperienced taxable individual investors. For more information on the complex issues regarding taxes and margin considerations, please visit and

Uses Of Equity Derivatives By Institutional Investors

In a 1999 Greenwich Associates survey of 118 institutional investors (including mutual funds, hedge funds, investment counselors, pensions and endowments), here are the numbers of respondents who reported using equity derivatives for various reasons:

While several institutional investors have used stock index futures or options to become equitized for 'investing' purposes (i.e., to gain synthetic exposure to 'traditional' investments such as U.S. stocks), the rest of this paper will focus primarily on using index options and futures to gain exposure to certain alternative investments.


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