Low Volatility Equity
Objective: Total Return
Rampart designed the Low Volatility Equity (LVE) strategy for investors who seek to dampen the volatility of their portfolios as markets fall without foregoing the opportunity to participate in rising markets. There are three versions of LVE, based on degree of defense:
- LVE-D (maximum defense)
- LVE (moderate defense)
- LVE-A (minimum defense)
The LVE strategy seeks to outperform the S&P 500® Index (or some other equity benchmark) over a full market cycle while generating attractive risk-adjusted returns. The LVE strategy combines two options tools — an income-producing strategy (index call selling) and a downside, volatility-dampening strategy (VIX1 call buying). The dual objective is to maximize upside potential and to dampen downside risk. While selling calls can restrict upside potential, Rampart’s proprietary process for determining and varying strike price levels seeks to improve upon the performance of more traditional call writing strategies.
Rampart writes (sells) S&P 500® Index calls against the full notional value of a portfolio. The strike price level of the calls (from at-the-money to out-of-the-money) is mathematically driven and will vary based on proprietary signals driven by (i) market volatility, as measured by VIX, and (ii) technical trends analysis. These systematic processes seek to optimize returns and to reduce the drag on performance normally associated with option strategies. Typically, Rampart sells one-month S&P 500® Index calls that are exchange traded.
For the LVE and LVE-D versions, Rampart purchases call options on VIX futures to assist when the S&P 500® Index experiences downside moves. As a pure play on volatility, VIX options can be very beneficial to the portfolio because their value generally increases exponentially with market price decreases (VIX generally is negatively correlated to the S&P 500®). The percentage of protection is determined by S&P 500®volatility futures levels.
Any surplus premium generated in excess of that needed to purchase the VIX call options is reinvested in the underlying portfolio. Conversely, any shortfall in funds from the option rolls (closing existing positions and opening new ones) is provided through the sale of portfolio positions or some other client-directed source.
- The defensive aspect of LVE is critical to the objective of outperforming the market over the long term, as it seeks higher compound rates of return compared to higher volatility equity portfolios.
- Further, the use of systematic processes removes the influence of emotional reactions to market moves.
Important Risk Considerations:
Performance will be affected by a change in the relationship between the VIX and the S&P 500® Index. VIX generally falls when the S&P 500® rises, and vice versa.
If our technical-based signals do not identify the correct trend and conditions, the performance of an account will be negatively affected.
There is the potential that the portfolio will not participate in the upside appreciation if the S&P 500® Index moves above the short call strike written in an account.
Buying call options risks the loss of the premium paid for those options.
Margin requirements for option writers are complicated and not the same for each type of underlying security. They are subject to change and can vary from brokerage firm to brokerage firm. As they have significant impact to the risk/reward profiles of each trade, writers of options (whether they be calls or puts alone or as part of multiple position strategies such as spreads, straddles, or strangles) should determine the applicable margin requirements from their brokerage firms and be sure that they are able to meet those requirements in case the market turns against them.
There is no assurance that Rampart Investment Management will be successful in implementing the Low Volatility Equity strategy (e.g., identifying or exploiting option pricing inefficiencies).
1 VIX is the ticker symbol for the CBOE (Chicago Board Option Exchange) Market Volatility Index®, a measure of the implied volatility of the S&P 500® Index.