CBOE S&P 500 BuyWrite Index (BXM): Explained | TIOmarkets
BY TIO Staff
|June 27, 2024The CBOE S&P 500 BuyWrite Index (BXM) is a benchmark index that represents a hypothetical buy-write, or covered call, strategy on the S&P 500 index. This strategy involves buying the stocks in the S&P 500 and simultaneously writing, or selling, call options on the S&P 500 index.
The BXM was introduced by the Chicago Board Options Exchange (CBOE) in 2002 to provide a benchmark for tracking the performance of a buy-write strategy. This strategy is often used by investors looking to generate income and reduce volatility in their portfolio.
Understanding the BXM
The BXM is calculated by applying a buy-write strategy to the S&P 500 index. This involves buying all the stocks in the S&P 500 index and then writing call options against the index. The call options are written at the money, which means the strike price of the options is the same as the current price of the index.
The income generated from selling the call options is added to the total return of the S&P 500 index to calculate the return of the BXM. If the S&P 500 index rises, the call options will be exercised and the investor will have to sell the stocks at the strike price. If the index falls, the options will expire worthless and the investor keeps the income from selling the options.
Benefits of the BXM
The BXM provides a benchmark for investors who want to use a buy-write strategy. By comparing their performance to the BXM, investors can see how well they are doing. The BXM also provides a way for investors to see how a buy-write strategy would have performed in the past.
Another benefit of the BXM is that it can help reduce volatility. The income from selling the call options can help offset any losses from a fall in the price of the S&P 500 index. This can make the BXM less volatile than the S&P 500 index.
Limitations of the BXM
While the BXM can provide a useful benchmark, it does have some limitations. One limitation is that it assumes that the investor is able to sell call options at the money and at the current market price. In reality, this may not always be possible.
Another limitation is that the BXM does not take into account transaction costs. The cost of buying the stocks and selling the options can reduce the return of the strategy. The BXM also assumes that the investor is able to reinvest the income from selling the options, which may not always be possible.
How the BXM is Calculated
The BXM is calculated by applying a buy-write strategy to the S&P 500 index. This involves buying all the stocks in the S&P 500 index and then writing call options against the index. The call options are written at the money, which means the strike price of the options is the same as the current price of the index.
The income generated from selling the call options is added to the total return of the S&P 500 index to calculate the return of the BXM. If the S&P 500 index rises, the call options will be exercised and the investor will have to sell the stocks at the strike price. If the index falls, the options will expire worthless and the investor keeps the income from selling the options.
Step-by-Step Calculation
The first step in calculating the BXM is to determine the price of the S&P 500 index. This is the price that will be used to write the call options.
Next, the call options are written at the money. This means that the strike price of the options is the same as the current price of the index. The income from selling the options is then calculated.
The final step is to add the income from selling the options to the total return of the S&P 500 index. This gives the return of the BXM.
Adjustments to the Calculation
There are some adjustments that can be made to the calculation of the BXM. One adjustment is for dividends. If a stock in the S&P 500 index pays a dividend, the dividend is added to the return of the BXM.
Another adjustment is for changes in the S&P 500 index. If a stock is added or removed from the index, the BXM is adjusted to reflect this change.
A third adjustment is for changes in the price of the S&P 500 index. If the price of the index changes, the strike price of the options is adjusted to match the new price.
Using the BXM in Trading
The BXM can be used in trading to implement a buy-write strategy. This involves buying the stocks in the S&P 500 index and then writing call options against the index. The call options are written at the money, which means the strike price of the options is the same as the current price of the index.
The income generated from selling the call options is added to the total return of the S&P 500 index to calculate the return of the BXM. If the S&P 500 index rises, the call options will be exercised and the investor will have to sell the stocks at the strike price. If the index falls, the options will expire worthless and the investor keeps the income from selling the options.
Implementing a Buy-Write Strategy
To implement a buy-write strategy, an investor first needs to buy the stocks in the S&P 500 index. This can be done by buying an ETF that tracks the S&P 500 index.
Next, the investor needs to write call options against the index. This can be done by selling call options on an ETF that tracks the S&P 500 index. The options should be written at the money, which means the strike price of the options is the same as the current price of the ETF.
The final step is to monitor the options. If the price of the ETF rises, the options will be exercised and the investor will have to sell the ETF at the strike price. If the price of the ETF falls, the options will expire worthless and the investor keeps the income from selling the options.
Benefits and Risks of a Buy-Write Strategy
A buy-write strategy can provide a steady income stream and reduce volatility. The income from selling the options can help offset any losses from a fall in the price of the S&P 500 index. This can make a buy-write strategy less risky than simply buying the S&P 500 index.
However, a buy-write strategy also has risks. If the S&P 500 index rises sharply, the investor will have to sell the ETF at the strike price, which could result in a loss. There is also the risk that the options will not be exercised, which would mean the investor does not receive any income from selling the options.
Another risk is that the investor may not be able to sell the options at the money and at the current market price. This could reduce the income from the strategy. There is also the risk of transaction costs, which can reduce the return of the strategy.
Comparing the BXM to Other Indexes
The BXM can be compared to other indexes to see how a buy-write strategy would have performed in different market conditions. For example, the BXM can be compared to the S&P 500 index to see how a buy-write strategy would have performed compared to simply buying the S&P 500 index.
The BXM can also be compared to other strategy indexes. For example, the CBOE has a put-write index that represents a strategy of selling put options on the S&P 500 index. By comparing the BXM to the put-write index, investors can see how a buy-write strategy compares to a put-write strategy.
Comparing the BXM to the S&P 500
When comparing the BXM to the S&P 500, it is important to consider both the return and the risk. The return of the BXM is typically lower than the return of the S&P 500. This is because the income from selling the options is added to the return of the S&P 500 to calculate the return of the BXM.
However, the risk of the BXM is also typically lower than the risk of the S&P 500. The income from selling the options can help offset any losses from a fall in the price of the S&P 500. This can make the BXM less volatile than the S&P 500.
Comparing the BXM to Other Strategy Indexes
The BXM can also be compared to other strategy indexes. For example, the CBOE has a put-write index that represents a strategy of selling put options on the S&P 500 index. By comparing the BXM to the put-write index, investors can see how a buy-write strategy compares to a put-write strategy.
When comparing the BXM to other strategy indexes, it is important to consider both the return and the risk. The return of the BXM is typically lower than the return of other strategy indexes. This is because the income from selling the options is added to the return of the S&P 500 to calculate the return of the BXM.
However, the risk of the BXM is also typically lower than the risk of other strategy indexes. The income from selling the options can help offset any losses from a fall in the price of the S&P 500. This can make the BXM less volatile than other strategy indexes.
Conclusion
The CBOE S&P 500 BuyWrite Index (BXM) is a benchmark index that represents a hypothetical buy-write strategy on the S&P 500 index. This strategy involves buying the stocks in the S&P 500 and simultaneously writing call options on the S&P 500 index.
The BXM can provide a useful benchmark for investors who want to use a buy-write strategy. It can also help reduce volatility and provide a steady income stream. However, a buy-write strategy also has risks, including the risk of having to sell the stocks at the strike price if the S&P 500 index rises sharply.
By understanding how the BXM is calculated and how it can be used in trading, investors can make more informed decisions about whether to use a buy-write strategy.
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