While maximizing returns is often the primary goal in investing, mitigating losses can be just as crucial. This is especially true for investors who find the pain of losing significantly more distressing than missing out on potential gains. Loss aversion, a well-known behavioral phenomenon, explains why for some investors, the pain of losing is psychologically twice as powerful as the pleasure of gaining. This concept has driven innovation in the field of risk management, leading to the development of strategies like Cboe’s Buffer Protection Indices.
Cboe Global Markets, Inc. (CBOE) offers these indices, which are part of a family of Target Outcome Indices designed to provide a range of potential investment outcomes. Historically, such outcomes were only accessible through structured notes or certain insurance products. Cboe’s Buffer Protection Indices are particularly effective in bear, range-bound, or modest bull market environments. They aim to provide a buffer against downside losses over a defined period while still offering the potential for growth up to a predetermined maximum level.
These strategies seek to deliver returns comparable to the S&P 500 Index but with lower volatility and reduced downside risks in most market conditions. However, their effectiveness is somewhat diminished when the stock market is experiencing a rapid rally.
Earlier this year, Cboe commissioned a white paper to examine the performance of three Cboe Buffer Protection Indices against the S&P 500 Index and Russell 2000 Index over a 17-year period. The analysis revealed that the Cboe Buffer Protect Indices demonstrated superior risk management characteristics compared to their underlying stock market counterparts. These indices exhibited lower volatility, reduced market beta, decreased Value-at-Risk, and less severe maximum drawdowns.
This enhanced downside protection did not come at the expense of risk-adjusted returns. The Cboe Buffer Protect Indices maintained similar or slightly higher Sharpe ratios compared to the stock indices. The white paper further emphasized that the risk mitigation benefits of these indices were particularly evident during periods of significant market stress. For instance, in the volatile market years of 2008 and 2022, the Cboe Indices significantly outperformed the stock indices, incurring substantially lower losses.
These findings suggest that the Cboe Buffer Protect Indices may offer investors an effective way to participate in market upside while providing a cushion against downside risk.
The financial landscape witnessed a significant surge in options-based ETF solutions in 2023, fueled by the considerable market volatility experienced in 2022. This trend directly addressed the significant drawdowns observed in equity and fixed-income markets during the previous year. These new ETF offerings addressed two key investor concerns: minimizing portfolio volatility and generating income.
Over 40 new buffer ETFs were launched throughout 2023 to manage portfolio volatility. This proliferation of buffer ETFs indicates the growing investor appetite for risk-mitigation tools in an increasingly uncertain economic environment. As a leading derivatives-based index provider, Cboe’s Buffer Protect Indexes have played a significant role in making buffer-protect strategies more transparent and widely available. Various ETF manufacturers have leveraged Cboe’s expertise in designing and bringing their own buffer ETF solutions to market.
Cboe’s Buffer Protection Indices exemplify the power and versatility of options and how investors can leverage them to enhance their portfolios. Cboe possesses the capabilities to realize complex index concepts, backed by a large pool of derivatives data and supplemented with proprietary pricing algorithms. These indices demonstrate Cboe’s commitment to innovation by enhancing return consistency and mitigating the downside risk associated with long exposure to equity market indices like the S&P 500 Index.
This approach effectively addresses the fact that losses can disproportionately affect investments. The remaining capital must generate significantly higher returns to recover from a decline. As losses increase, the required return to reach the break-even point grows much faster. Cboe’s Buffer Protection Indices help investors engage with the market while providing a buffer against potential losses, safeguarding downside performance.
