By Derek Moore
Who Is This Update For?
Many advisors have clients currently in ZBIG (ZEGA Buffered Index Growth) strategies that contain option positions on SPY (S&P 500 Index ETF) that expire this month (December 2022). As allocators and investors with ZBIG know, it is a point-to-point strategy. We typically use options with 2 or 3 years until expiration as those tend to be the most efficient means to meet the goals of the strategy. As positions approach maturity and expiration, we rebuild those positions with new SPY options going out in a few years, usually to the longest dated options available.
Other accounts may hold maturities of 2023 or 2024. For those accounts they are set in place and will not be changing.
What You’ll See in Accounts
In the past, during the maturity years, there were opportunities to roll early during the year to the longer dated options. Usually this is done to lock in gains and reset the buffer level. However, this year, with the declining market, that opportunity did not present itself, so we find the strategy running all the way into December.
As mentioned above, typically the longer-dated options are a more efficient use of cash and produce a greater upside capture. Unfortunately, the longest dated SPY contracts available only go out to Jan 2025. And while that is OK, we’d much prefer to wait for the Dec 2025’s to get nearly a full 3 years to the build. The good news is that once we see the expiration next week of the 2022’s, we’ll start to see the Dec 2025’s become available.
Additionally, when the new rung of leap options first come out, in our experience the pricing isn’t optimal until they settle. We typically see wider bid ask spreads that would lead to your clients paying more than they normally would. For this reason ZEGA’s traders will replace the expiring Dec 2022 options with Feb or March of 2023 options. You might be thinking, I thought ZBIG accounts were built with 2-3 year maturities?
They are, but using closer expirations that are pricing better until the new 2025 vintage is out for a bit allows us to get a smoother and better value for your clients.
What you’ll see is the team then rolling out of those new Feb/March 2023s and into December 2025s.
Having done this for a bit, we think this will be better pricing for your clients and normally these options going out 3 years will enable an optimized risk graph commensurate with the strategy goals.
Fixed Income Portion of Portfolios Refresh
For these same accounts, they have been holding a combination of US Treasuries and a synthetic short HYG put spread.
As you probably know, bonds have had a down year in 2022, but switching to this construct in the final year of maturity enabled accounts to realize less losses. At the same time, as accounts are rebuilt for the 2025 maturities, it allows us to go back into short duration high yield and short duration senior loan ETFs at lower prices and higher dividend yield.
You should see the fixed income portion done at the same time as the option position adjustments.
There will be a second adjustment to the size of the fixed income later when our traders put the final 2025 expiration options in the accounts as well.
Did ZBIG Do Its Job?
A quick answer is yes considering accounts did not move below the 25% buffer zone.
Many of your clients saw ZBIG strategy accounts come down as the market sold off, but generally this was just a give-up of profits rather than losses from entry. Fixed income provided dividends that helped fund the long market exposure. These 2022 maturities also have the benefit of using much lower strikes that will have 3 years of time to capture any market recovery while still maintaining downside buffers.
It’s been a while since we posted anything around our ZBIG strategy and with this tactic we’ll be employing, we wanted to let you see a bit of the details and the why behind it.
As always reach out to a member of the ZEGA team with questions on this adjustment or how ZBIG can let your clients get long the market with a buffered downside.