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In Brief

  • Gateway Index/RA Composite (the Composite) gained 3.64%, net of fees, in the fourth quarter compared to the 9.07% return of the S&P 500® Index. For the full year, the Composite returned 11.29%, net of fees, relative to the 31.49% return of the S&P 500® Index. The Bloomberg Barclays U.S. Aggregate Bond Index returned 0.18% and 8.72% for the fourth quarter and full year, respectively. (A GIPS® Composite Report is included with this Commentary.)
  • The Composite’s return for the fourth quarter was better than expected given the equity market’s below-average implied volatility level, while lagging performance relative to the S&P 500® Index was expected as the equity market advanced at a well-above-average rate.
  • Removal of trade uncertainty helped propel the S&P 500® Index upward as phase one negotiations between the U.S. and China were finalized and set to be signed in early 2020, the United States-Mexico-Canada Agreement advanced to the Senate, and a decisive U.K. election brought the Brexit process closer to an end.
  • The Cboe® Volatility Index® (the VIX®) averaged 13.99 for the fourth quarter of 2019 and 15.39 for the full year, both below its historical average of 19.15. The 2019 closing high for the VIX® was 25.45 on January 3, as the equity market began its recovery from near bear market territory in December 2018. The 2019 low for the VIX® was 11.54 on November 26 and it closed the year at 13.78. Average implied volatility exceeded realized volatility for the year as the S&P 500® Index had a 12.47% annualized standard deviation of daily returns, while the Composite* had a standard deviation of 5.41%.
  • Despite a strong equity market advance in 2019, implied volatility levels remained above the historic lows set in 2017. This helped the Cboe® S&P 500 BuyWriteSM Index (the BXMSM) and the Cboe® S&P 500 PutWriteSM Index (the PUTSM) deliver their best annual returns since 2009 even though the VIX® was persistently below its historical average throughout the year. Option writing returns were also supported by a positive spread between implied and realized volatility in all but one month of 2019.


Source: Bloomberg, L.P.

Market Recap

The S&P 500® Index returned 9.07% for the fourth quarter of 2019, resulting in a return of 31.49% for the year. The fourth quarter advance was steady with the S&P 500® Index posting returns of 2.17%, 3.63% and 3.02% in October, November and December, respectively.

Fourth quarter returns were buoyed by increasing clarity around U.S. trade negotiations. Specifically, ‘phase one’ negotiations between the U.S. and China were finalized and set to be signed in early 2020. Additionally, the United States-Mexico-Canada Agreement advanced to the Senate for ratification after Democrats in the House of Representatives agreed to modifications negotiated with the Trump Administration and a decisive U.K. election brought the Brexit process closer to an end. The domestic economic environment showed strength on many fronts. On December 20, the final read of Q3 GDP growth came in at 2.1%, at the top of consensus estimates. The unemployment rate settled the quarter at 3.5%, a 50-year low, after nonfarm payrolls crushed expectations. A tight employment situation and a confident consumer led the year-over-year change for the November Consumer Price Index to 2.1%, at the top of expectations and in line with the Federal Reserves (the Fed) 2% target. On the corporate front, third quarter earnings declined less than 1% quarter-over-quarter and grew nearly 2% year-over-year. Though earnings shrank in aggregate for the quarter, results were better than expected with nearly 82% of reporting companies meeting or exceeding analyst estimates.

The fourth quarter market advance, combined with a first quarter return of 13.65%, drove the S&P 500® Index to its best annual return since 2013 and an annual return of over 30% for just the fifth time in the last three decades. The strong first quarter return followed steep losses in the fourth quarter of 2018 that were primarily driven by concerns of overly tight monetary conditions in the face of slowing global economic growth. After four rate hikes in 2018 and expectations of more in 2019, the first quarter recovery was fueled by the Fed rhetoric indicating a potential policy shift. The year began with talk of fewer-than-expected rate hikes in 2019 plus a slower reduction in the size of the Fed’s balance sheet. Fed policy ultimately evolved into three rate cuts and a resumption of balance sheet growth in the second half of the year.

Between the first and fourth quarters of 2019, the equity market advance was choppy and moderate as the market processed uncertainty over Fed policy, trade and the global economy. Though the S&P 500® Index returned 6.08% over the course of the second and third quarters, it experienced two sizeable drawdowns of 6.62% and 5.99%, occurring from May 3 through June 3 and July 26 through August 14, respectively. The first drawdown was driven by unease over trade and global economic growth as tensions between the U.S., China and Mexico escalated in concert with slowing growth in China. The equity market was particularly volatile during the second drawdown as the S&P 500® Index had three separate one-day declines of over 2.50% in August. The last time a month included three one-day declines of that magnitude was September 2011 when the equity market was reeling from the credit rating downgrade of U.S. government debt. Despite these mid-year pullbacks and persistent concern over U.S. monetary policy, global trade, and economic growth, implied volatility levels were persistently below their historical average in 2019.

The VIX® averaged 13.99 for the fourth quarter of 2019 and 15.39 for the full year, both below its historical average of 19.15. The 2019 closing high for the VIX® was 25.45 on January 3, as equity markets recovered from nearly-bear market territory in December 2018. The 2019 low for the VIX® was 11.54 on November 26, amidst strong returns in the equity market, before it closed the year at 13.78. Consistent with its typical relationship, average implied volatility exceeded realized volatility, as measured by the annualized standard deviation of daily returns for the S&P 500® Index, which was 12.47% for the year. The implied versus realized volatility relationship was consistent throughout 2019 with average implied volatility exceeding realized volatility in 11 months. The singular exception was August, when realized volatility averaged 22.70% while the implied volatility response to the market’s large drawdown and sharp daily losses was muted, resulting in a VIX® average of just 18.98 for the month.



Source: Bloomberg, L.P.


The Bloomberg Barclays U.S. Aggregate Bond Index returned 0.18% for the fourth quarter of 2019, resulting in a return of 8.72% for the year. The yield on the 10-year U.S. Treasury Note (the 10-year) ended the third quarter at 1.66% and rose to a fourth quarter high of 1.94% on November 8 before falling to end the year at 1.92%. Over 2019, the yield on the 10-year generally declined as the Fed shifted back into accommodative monetary policy after an attempt to normalize in 2018. During the tumultuous month of August, the spread between the 2- and 10-year U.S. Treasury Notes reflected an inverted yield curve with the 2-year yield exceeding the 10-year yield by 5 basis points (bps). As equity market volatility subsided, the spread between the 2- and 10-year turned positive and widened to a 2019 high of 35 bps on December 31.

Gateway Index/RA Composite Performance

The Composite returned 3.64%, net of fees, in the fourth quarter, lagging the S&P 500® Index by 543 bps and bringing its year-to-date return to 11.29%, net of fees. The Composite’s return for the quarter was better than expected given the equity market’s below-average implied volatility level. The investment team actively adjusted index option strike prices upward as the market advanced over the course of the quarter, which maintained market exposure and was additive to the Composite’s absolute return. The Composite’s lagging performance relative to the S&P 500® Index was expected as the equity market advanced at a well-above-average rate.

The portfolio performance, contributions, annualized standard deviation and portfolio statistics quoted for the Composite in the following paragraphs are those measured by a representative account.

The Composite’s underlying equity portfolio returned 9.39% for the quarter, a positive performance differential of 32 bps relative to the S&P 500® Index. Written index call option and purchased index put option positions both detracted from the Composite’s return in each month of the quarter, as expected during periods when the equity market advances with below-average volatility. In achieving its low-volatility objective, the Composite‘s annualized standard deviation of daily returns for the quarter was 4.16% compared to 9.43% for the S&P 500® Index. The Composite exhibited a beta to the S&P 500® Index of 0.42 for the quarter.

In managing the Composite’s portfolio of written index call options throughout the quarter, Gateway’s investment team focused on exchanging option contracts well in advance of their expiration dates for ones with later expiration dates and higher strike prices. This was in an effort to maintain a typical amount of equity market exposure as the market advanced while taking measures to protect the Composite from the potentially adverse impact of a sharp reversal in market direction. For the index put option component of the strategy, the investment team managed the cost of downside protection by trading select put option contracts in advance of their expiration while keeping weighted-average time to expiration relatively extended.

At the end of the quarter, index call options were sold against over 95% of the equity portfolio’s value and had a weighted average strike price between 1.5% in-the-money and 1.5% out-of-the-money, 57 days to expiration and annualized premium to earn between 7.5% and 10.0%. Index put options covered more than 95% of the portfolio and had a weighted average strike price between 10.0% and 12.5% out-of-the-money, 58 days to expiration and an annualized cost of less than 2.5%. Relative to the beginning of the quarter, this positioning represented less potential net cash flow and lower market exposure.


Source: Bloomberg, L.P.


Throughout the year, the Composite’s two-part option strategy consistently reduced risk and delivered equity market participation during market advances while mitigating losses during market declines. Similar to the fourth quarter, the Composite’s lagging performance during the strong market advance of the first quarter contributed to its underperformance relative to S&P 500® Index for the year. In the first quarter, the Composite returned 5.01% compared to the S&P 500® Index’s return of 13.65%. Below-average implied volatility in the first quarter resulted in net cash flow from the option strategy that was low relative to the market’s well-above-average rate of advance. Over the course of the second and third quarters when the market advance was choppy and more moderate, the Composite returned 2.13%, compared to the S&P 500® Index’s return of 6.08% while providing significant downside protection during the brief but sharp market declines. Specifically, the Composite returned -3.56% from May 3 through June 3 and -2.73% from July 26 through August 14 as compared to -6.62% and -5.99%, respectively, for the S&P 500® Index during those same periods.

Market Perspective

Implied volatility moderated in 2019, after spending much of 2017 at or near record lows and experiencing extreme highs during two volatility spikes in 2018. In 2019, the VIX® adhered to the usual pattern of falling during market advances and increasing during market pullbacks. However, with a 2019 closing low of 11.54 on November 26 and a closing high of 25.45 on January 3, it did not collapse to record lows during the strong equity market advances in Q1 and Q4, nor did it spike to extremes during the market drawdowns of Q2 and Q3.


1: Implied volatility shown is based on the VIX® daily closing values. 2: Realized volatility is based on the standard deviation of daily returns for the S&P 500® Index. Source: Bloomberg, L.P.


Though the range of implied volatility was more moderate in 2019, it maintained the persistent below-average trend of recent years. The VIX® averaged 15.39 for the year, below its long-term average of 19.15. Despite below-average implied volatility levels, option writing indexes such as the BXMSM and the PUTSM delivered returns that were not only above their long-term averages but also their best annual returns since 2009. The lack of a collapse in implied volatility despite strong equity market advances helped option writing returns in 2019. Option writing returns were also helped by a positive spread between implied and realized volatility. Realized volatility, based on the standard deviation of daily returns for the S&P 500® Index, came in at 12.47% for 2019, about three percentage points lower than average implied volatility. Notably, the relationship between implied and realized volatility returned to normal in 2019 after flipping in 2018 for the first time since 2009. Moreover, the relationship was persistent throughout the year with monthly averages for implied exceeding realized volatility in all but one month of the year.

What roles can option writing strategies play in investor portfolios in this environment? If current market and economic trends continue in 2020, then both the equity bull market and the U.S. economic expansion are poised to enter their 12th consecutive year in March and July, respectively. While the economic expansion has already set a record for duration, the equity market begins 2020 just a year-and-a-half shy of the longest bull market on record. A continuation of economic expansion, the equity bull market and the low volatility trend is uncertain due to several potential threats including domestic politics, geopolitical tensions and monetary policy challenges.

For investors who anticipate that recent market tranquility is temporary, option writing strategies that seek to consistently deliver lower risk and less downside than the equity market may be an appealing way to reduce equity market exposure and risk.

Investors with a more sanguine outlook may find the absolute return and risk-adjusted return potential of option writing strategies appealing relative to other lower volatility investments. A possible continuation of richer-than normal option pricing combined with low realized volatility creates the potential for option writing strategies to deliver attractive risk-adjusted returns with lower-than-normal volatility. Attractive risk-adjusted returns never go out of style and, in the current environment of low interest rates with the potential to rise over time, there are possible advantages to seek returns through allocations to option writing strategies. If low or rising interest rates keep bond market returns depressed, diversified investors may benefit from investments that do not have interest rate sensitivity and can complement intermediate to long-term bonds’ historical profile of low volatility and attractive risk-adjusted returns.

In either application, option writing exposure to richly-priced implied volatility has the potential to generate attractive risk-adjusted returns over the long-term.



1The BXMSM is a passive total return index designed to track the performance of a hypothetical buy-write strategy on the S&P 500® Index. The construction methodology of the index includes buying an equity portfolio replicating the holdings of the S&P 500® Index and selling a single one-month S&P 500® Index call option with a strike price approximately at-the-money each month on the Friday of the standard index-option expiration cycle and holding that position until the next expiration. *The portfolio performance and annualized standard deviation reflected for the Composite are those measured by a representative account. This information represents supplemental information to the GIPS® Composite Report. This representative account was selected as it is the largest account in the Composite.


2019 Q4 Flagship (Index/RA) Commentary
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