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Alternatives to Alternative Assets: Assessing S&P 500 Index Option Strategies as Hedge Fund Replacements

Hedge funds should deliver good risk-adjusted returns and provide diversification for investors’ portfolios. However, the performance of hedge funds has deteriorated in recent years and many investors may not find investment in hedge funds suitable, due to the high costs, illiquidity, and lack of transparency. The focus of this study is to examine whether equity index option-based strategies may deliver the same coveted ideal hedge fund return characteristics, that is, good risk-adjusted returns, mitigated risk measures, and added diversification. A total of seven S&P 500 Index-based generic option-writing strategies, named CP100 to CP0, are analyzed and compared with a comprehensive set of fourteen Credit Suisse hedge fund indexes using volatility or beta as matching metrics. The three series of CP100, CP80, and CP50, can be viewed as a solid suite of liquid alternatives to hedge funds. They match the fourteen Credit Suisse hedge fund indexes on beta levels, but deliver better risk-adjusted returns. Their annual returns and risk measures are better than or on par with the hedge fund indexes, except for the Credit Suisse Global Macro Index, which may be matched by a levered version of the CP100 option strategy. This suite of three option strategies are transparent, liquid, inexpensive, and easy to implement. They can achieve the same goals of hedge funds: attractive risk-adjusted returns, subdued risks, and added diversification. They may play multiple and important roles in institutional investors’ portfolios.