Allianz Global Investors
Options:
A Compelling
Opportunity to
Enhance Equity
May 2017
Jeff Sheran, CFA
Managing Director
+1 (212) 739-3034
For Institutional Use in One on One Presentations Only.
STR.SA250.CM.IMF.PBK.NY.1703 | 151406
Options: A Compelling Opportunity to Enhance Equity
 The efficiency of US large-cap equity is driving a massive shift to passive investing
 But equity is too big an allocation in which to ‘punt’ on outperformance
 Look to options
2
Benefits of Enhancing Equity via Options
 Low correlation profile
– Outperformance potential independent of market movements
– Asymmetric ability to outperform in both up and down markets
 Non-directionality
– No need to correctly forecast the market
 Both return potential and risk management
– Options’ versatility enables portfolios to optimize the balance between return and risk
3
Option Characteristics
 The right to buy or sell an underlying asset at a specific price on a certain date
– Can be traded on a stock, an index, or other types of assets
– Insurance analogy
 Multiple pricing factors
– Terrific opportunity for mathematical innovation
 Exchange-traded instruments
– Liquidity, transparency, daily pricing
– Sophisticated but easy to implement
4
Option Building Blocks
Expected Payoff Examples
 Put options
Put Option (S&P 500 Index options)
- Holder can sell the underlying to the
writer at a given price at expiration
Seller
1,405 Put
$600
Buyer
$400
Payoff
$200
- Holder is expecting the underlying to
decline in value
-$200
-$400
- Writer (seller) collects ‘premium’ in
exchange for downside risk
 Call options
-$600
-10
- Writer (seller) collects ‘premium’ in
exchange for upside risk
-8
-6
-4
-2
0
2
4
6
8
10
S&P 500 Index Level (%)
Call Option (S&P 500 Index options)
Seller
1,405 Call
$600
- Holder can buy the underlying from the
writer at a given price at expiration
Buyer
$400
$200
Payoff
- Holder is expecting the underlying to
increase in value
$0
$0
-$200
-$400
-$600
-10
-8
-6
-4
-2
0
2
4
6
8
10
S&P 500 Index Level (%)
The above information is intended for general educational purposes only and illustrates limited examples of certain characteristics and/or of behavior patterns for particular types of options and/or markets. See additional disclosure at
the end of this presentation.
5
Observations About Options
 Puts are typically overpriced
– The world is long equity
– Excess demand for hedging
 Calls are typically underpriced
– Call writing is a widely used strategy
– Sellers may not be compensated enough for the risk of forgoing equity appreciation
 Implied volatility typically exceeds realized volatility
– VIX Index (‘Investor Fear Gauge’) overstates risk of a market decline…
– …But not always
OCFPOI4
6
‘Long Volatility’ Strategies
PROS
 Designed to generate profits in highly
volatile markets
 Provides tail-risk protection against
market shocks
CONS
 Very costly due to time-premium erosion
and implied-over-realized spread
 Often relies on uncommonly large market
move for strategy to pay off
7
‘Short Volatility’ Strategies
PROS
CONS
 Designed for consistent profits in
normal markets
 Tail risk exposure: Can the strategy
survive a market shock?
 Time is on your side, as is
implied-over-realized spread
 Rely on history repeating itself
8
Combination ‘Long-Short’ Strategies
 Extract positive features from both exposures
 Less dependent on direction of volatility
 Challenge is to avoid a zero-sum game
9
You Don’t Have to Index
 Unlike large-cap equity, options provide sustainable excess return potential
 Potential for much higher information ratio than passive or traditional active equity
 Pursue alpha where otherwise resigned to just index-like results