The market, as measured by the S&P 500®, began the new year at all-time highs only to immediately retrace those gains back to May of 2021 levels. In a very unusual quarter, a return of (4.6%) seems like a win for investors given the extent of the correction, which at one point saw the market down by more than 13% in February. Market volatility was spurred by a combination of factors, including inflation topping out at 7.9%, which led to an inverted yield curve between 10yr/2yr bonds. An already elevated inflation reading coming into the quarter was further exacerbated by sanctions placed on Russia by the U.S. and EU after Russia invaded Ukraine.
With oil (WTI) rising by 40%, natural gas 62%, and agricultural products up 22%, Fed posture moved to project aggressive forward policy actions, possibly raising Fed Fund rates by 50 bps at each of the next several meetings. In addition, the Fed articulated an acceleration of the quantitative tightening schedule with bond roll-offs of $95 billion every month from its $9 trillion balance sheet, possibly beginning in May. As geopolitical and macroeconomic events together working to obscure visibility into economic growth, and thus earnings, volatility as measured by the VIX Index, more than doubled from 17 to 38 in late January and stayed persistently elevated through the first week of March before moderating toward the back half of the month and falling to the previous lows on the year.
Call Option Premium:
Given the heightened volatility, premium capture was solid, averaging 1.2% on simple return which annualizes to a 4.8% run rate. For several quarters now, we have generally moved from 20 to 30 delta at initiation on the average short option position. We are capturing more premium by writing at the higher delta. For every position, the decision is made to maximize return by grabbing income through the option writes or allowing for more upside participation with less option premium. Given the lack of visibility into earnings discussed above, we have shifted to a more defensive stance with both our call writing and overall portfolio construction. Despite capturing a greater premium, average writes were initiated 10% out-of-money allowing for significant upside participation, which compares favorably to past quarters.
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