An options trading program marketed as a “Yield Enhancement” strategy to brokerage customers of UBS, reportedly including risk averse investors with substantial bond portfolios, has suffered a hard landing in November and December as the so-called “Iron Condor” index options spread-based scheme has reportedly delivered losses in excess of 20% of the capital committed.
UBS’s Yield Enhancement Strategy (“YES”) reportedly has over $5 billion under management and over 1,200 investors. Investors in YES must agree to commit capital to the program, a so-called “mandate,” which may take the form of securities or cash. The committed capital provides collateral for options spread trading in each investor’s account. Although marketed to bond investors, the bonds held by each investor have nothing to do with the YES strategy other than serving as collateral for the options trades. Some investors pledge other securities or cash as collateral for the YES program.
The YES strategy entails generating option premium income through the strategic sale and purchase of SPX (S&P 500) index option spreads. This strategy, which is also sometimes referred to as an “Iron Condor” spread, involves writing two vertical options spreads – a bear call spread and a bull put spread. Thus, this strategy entails four different options contracts, each with the same expiration date and differing exercise prices. The “Iron Condor” strategy involves writing both a short put and a short call against the SPX, with these naked, or uncovered, options are designed to generate income for the investor via the receipt of premium. Further, the “Iron Condor” strategy involves writing both a long put and long call against the SPX, with these trades, or options legs, designed to mitigate the risk associated with the uncovered options positions.
While the YES strategy may deliver solid returns in a market that neither rises nor falls substantially over relatively short time frames, the strategy’s inherent substantial risks become apparent in times of heightened stock market volatility. For example, earlier this year in February 2018, when markets turned volatile, a volatility index known as VIX spiked to extreme levels in excess of 20. During that same time frame, YES incurred its first substantial losses of 2018. Unfortunately, the February 2018 losses appear to represent only the beginning. YES investors have reportedly suffered losses in excess of 20% of their committed capital during November and December 2018 as markets once again turned volatile. Many investors found to their chagrin that their options positions incurred steep losses- far beyond what they had thought was possible- over very short periods of time.
Ultimately, options strategies like the iron condor amount to bets in favor of the time decay embedded in options (which have fixed expiration dates) versus volatility. On the one hand, an investor can pocket options premium income in those instances where the option — which has a finite lifespan and fixed expiration and is therefore properly viewed as a decaying asset — goes to zero and expires worthless. However, on the other hand, periods of pronounced market volatility can quickly lead to scenarios where the option premium is dwarfed by losses due to market volatility.
UBS reportedly marketed the “Yield Enhancement” strategy to high net worth investors as presenting limited risk while providing single-digit annual enhancement of returns on bond portfolios. This marketing angle may have appealed to risk-averse investors due to the lower bond yields available during the recent multi-year period of low interest rates.
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