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Mutual Funds Lag, While Proven, Responsible Options Strategies Take The Lead

Last Updated: October 3, 2020

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Mutual Funds Lag, While Proven, Responsible Options Strategies Take The Lead

Mutual Fund Underperformance. Fund Managers Continue to Underperform

Nearly 90% of mutual funds, like the kind in your 401k retirement plan, can’t even match the market (S&P 500). This is according to the SPIVA (S&P versus active management) analysis of data comparing performance.

Let's Look at the Statistics

  • 88.3% of large-cap mutual funds were outperformed by the S&P 500 over 5 years, January 1, 2012 - December 31, 2016.
  • When narrowing the focus over 3 years (January 1, 2014 - December 31, 2016), 93.4% of the large-cap funds were outperformed by the S&P.
  • In 2016, nearly 2/3 (66%) of these funds were outperformed by the S&P 500.
  • While managed funds continue to underperform, responsible options trading is gaining retail investor popularity with increased returns and less volatility.

So what's the reason for the lagging market performance of mutual fund managers? Is it really true that options strategies provide opportunities for investors to meet their investment objectives and goals?  

Let's take a dive into the following infographic.

mutual fund underperformance - proven options strategies continue to lead

Fund Manager Performance versus the CBOE Put Writing Strategy

The average mutual fund manager’s performance did not only lag the S&P 500.  Mutual funds and their active management more dramatically underperformed the CBOE put writing strategy (using the CBOE’s PutWrite Index, ticker symbol PUT).

So what does this mean for your money?  Well, over 30-year model retirement portfolio (the period measured is June 30, 1986 – January 29, 2016), the S&P500 would realize you an extra $450,000 in your retirement.

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And for the investor that turned to the a put writing strategy instead?  An extra $610,000. This is according to data that the CBOE analyzed, which compared how a put writing option strategy competes against buy-and-hold market performance.

The analysis that the CBOE performed was based on a comparison of several options strategies. Also, the performance may be based on any of the following CBOE options indices. These track their automated index, and trade in and out of positions within the index where appropriate:

CBOE Options Indices

Ticker Description
BXM CBOE S&P 500 BuyWrite Index. Strategy that purchases stocks in the S&P 500 index and each month sells at-the-money SPX index call options.
BXMD CBOE S&P 500 30-Delta BuyWrite Index. Covered call strategy that holds a long position indexed to the S&P 500 Index and sells monthly 30-delta out-of-the-money SPX index call options.
CLLZ CBOE S&P 500 Zero-Cost Put Spread Collar Index. Strategy that (1) holds a long position indexed to the S&P 500 Index; (2) on a monthly basis buys a 2.5% - 5.0% SPX put option spread; and (3) sells a monthly out-of-the-money SPX call option to cover the cost of the put spread.
PPUT CBOE S&P 500 5% Put Protection Index. Strategy that holds a long position indexed to the S&P 500 Index and buys a monthly 5% out-of-the-money SPX put option as a hedge.
PUT CBOE S&P 500 PutWrite Index. Strategy that purchases Treasury bills and sells cash-secured at-the-money put options on the S&P 500 Index.
Source: CBOE
Key Takeaway
Key Takeaway
Covered Calls Beat 401k Top Holdings for 10 Years

The second study, by Notre Dame and Mississippi State University, isolated the top ten holdings found in 401(k)'s from 2002-2012 and found that a covered call and covered combination strategy beat the performance of the portfolio.

Clearly the findings suggest that the use of options strategies improve the performance of a long-term (buy and hold) portfolio. However, it doesn’t completely speak to the question of why the above options strategies outperform the returns of a professional fund manager.

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Reasons for the Mutual Fund Manager’s Performance Lag (Vis-a-vis Overall Market and Options Strategies)

Then, what is the root for the clear mutual fund underperformance?  Surely Wall Street employs some of the best minds to actively manage these mutual fund products?

One explanation is that of fees.

Nerdwallet points out that index funds over the measuring period outperform funds by 0.80%, that were actively managed funds annually.  If we take fees into account, active managers performance was slightly higher than the index (0.12%) before fees. But what was charged in fees exceeded the value being created.

Keep in mind that all investment instruments are bought and sold for fees, including commissions (as in the case of individual or index options trading). The data they present accounts for this, resulting in an apples-to-apples comparison of fund manager’s performance vs. options strategies vs. the market.

Why Do Smart Individual Investors Take Part in Managed Funds Despite the Poor Performance and Excessive Fees?

Investors tend to take the path of least resistance when it comes to their investments. As of December 31, 2012, $7 trillion was invested in 23,000 actively managed funds, as well as ETFs. This represents an amount that is nearly three times the $2.5 trillion invested in passive funds.

Should Be Noted
Investors Take the Path of Least Resistance

Despite the fact that the sheer size of active investors makes it difficult (at best) for active fund managers to outperform the market once fees are netted out, investors are still willing to pay a premium for the familiar over-safe strategies with better overall performance.

Should Be Noted

The Case for an Options Trading Strategy

Increased Returns

Wilshire Analytics Applied Research Group in a 2016 paper (“Three Decades of Options-Based Benchmark Indices with Premium Selling or Buying: A Performance Analysis”) found that over the period 2007-2015 (around the time of the Great Recession through the economic recovery), the BMXD and PUT outperformed the S&P 500, except for the years 2012 and 2013 when equity asset classes surged.

Should Be Noted
+ click to expand
Should Be Noted
Options Trading Offers Increased Returns vs. Underperforming Mutual Funds

A look at a 30-year period of data (June 30, 1986 – December 31, 2016) also shows that the two CBOE Indexes outperformed the market by 7.1% (BXMD) and 1% (PUT) for the 30-year period.

Better Consistency & Reduced Drawdowns

If fund managers' only offering is decreased drawdowns from expensive management, then this is actually captured. And surely, more effective in proven, responsible options trading strategies.

Another point we should make here is the consistency of returns and the reduced drawdown which is illustrated in the graphic to the right.

If fund managers' only offering is decreased drawdowns from expensive management, then this is actually captured. And surely, more effective in proven, responsible options trading strategies.

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Options Trading Continues to Gain in Popularity

A look at the total historical trading volume for all options (i.e., calls and puts) for a period of ten years (2006 – 2015) shows annual average growth in the trading volume of 4%.

The total and daily average trading volume for the period (per annum) averages to 1.05 trillion and 4.2 million contracts respectively. This is a true testament to the popularity of options strategies as we usually see a decline in options trading in strong bull markets, as we've been in since 2012.

Total CBOE Options Contract Volume (2006-2015)

YEARTOTAL VOLUMEAVG DAILY VOLUME
20151,043,031,6304,139,014
20141,193,388,3854,735,668
20131,070,865,4724,249,466
20121,059,404,0894,237,616
20111,152,063,3974,571,680
20101,115,491,9224,426,555
20091,134,764,2094,503,033
20081,193,355,0704,716,818
2007944,471,9243,762,836
2006674,735,3482,688,189
Source: CBOE, Market Statistics 2015

Multiple Setups for Different Market Conditions (i.e., Bullish, Bearish, and Neutral)

Options allow you to pick a side of the market or even “straddle” the fence when moving sideways (neutral). An investor can choose to be ‘bullish’ in their outlook with a setup appropriate for a rising market.  Conversely, an options trader can be ‘bearish’ when the market is believed to be trending lower. Or could select a neutral strategy such as an at-the-money Put calendar, Iron Condor, or Straddles.

This ability to select a market conditional specific setup is advantageous to investors. Particularly those with a short time frame, not looking to tie up their capital - as with buy-and-hold strategies. This holds major advantage over a buy-and-hold strategy in the underperforming mutual fund market, which only participates to the upside.

Should Be Noted
Options Can Play All Sides of the Market

Underperforming mutual funds with their expensive active management can only profit in a bull market. Meanwhile, options traders are able to participate in bullish, bearing, and neutral markets.

Should Be Noted

The capital outlay for an options setup (the premium) is a fraction of the capital commitment when purchasing 100 shares of the option’s underlying asset.  

In fact, in most neutral options trading strategies, the investor is actually paid the premium at trade entry. The only requirement is to set aside margin to fulfill the potential obligation of buying the underlying shares.

Standardized Equity Options Contracts are Regulated, Efficient, and Liquid.

Equity options contracts are standardized, meaning the type, price, size, and expiration is matched on both sides of a transaction.

For every buyer there is a seller, allowing for early close-out of positions that meet a minimum profit target prior to either exercise or expiration. All equity options issued in the U.S. are cleared through the Options Clearing Corporation, leading to the market’s efficiency and liquidity.

While European-style contracts can only be exercised at expiration, American style options contracts can be exercised any time up to expiration (although both types of contracts can be closed out at any time prior to expiration). This allows for unprofitable positions to be closed out long before an unfavorable exercise takes place.

Should Be Noted
+ click to expand
Should Be Noted
Options are Serious Investments for Serious Traders & Investors

If you are looking at the data and giving strong consideration to options strategies for building a profitable portfolio, this can be a powerful compliment to your active fund management woes. 

Simply learning the ins and outs (risks and rewards) of trading options can produce results with less capital commitment and avoid the “follow the herd” mentality. In fact, the aforementioned subjects most investors to the active management rollercoaster.

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