KEY TOOLS FOR HEDGING AND TAIL RISK MANAGEMENT

Asset Consulting Group 231 South Bemiston Avenue, 14th Floor ♦ Saint Louis, Missouri 63105 ♦ 314 862 4848 1

EXECUTIVE SUMMARY OF KEY HIGHLIGHTS

Tail Risk in the Past 25 Years: Since mid-1986 the worst monthly declines for select indexes include: down 28.2% for the S&P GSCI Index, down 21.5% for S&P 500, down 20.2% for MSCI EAFE, and a decline of only 8.6% for the CLL Index (Exhibit B).

Tail Risk and Diversification in 2008: Changes for indexes in 2008 - S&P 500® down 37.0%; two indexes with options and stocks - CLLSM

down 23.6% and VXTHSM down 19.3%; three futures-based indexes (with no stock positions) -- VXMT, DyVX and VTRsk, respectively increased 83.9%, 132.3% and 174.3% (Exhibit A).

Lower Volatility: The CLL has incurred about 70% of the volatility of the S&P 500 over the last 26 years. Select portfolios with the VXTH and the future-based indexes have had less volatility than the S&P 500 over the last 70 months (Exhibits C, F, and O).

Exhibit A: Benchmark Indexes

Exhibit B: Histogram with Frequency of Monthly Returns for CLL and S&P 500 (July 1986 - January 2012)

BENCHMARK INDEXES

COLLAR OVER MORE THAN 25 YEARS

Exhibit B: Since mid-1986 the worst monthly declines for select indexes include: down 28.2% for the S&P GSCI Index, down 21.5% for S&P 500, down 20.2% for MSCI EAFE, down 17.4% for BXM, and a decline of only 8.6% for CLL Index.

Exhibit C: Returns and Volatility (July 1986 – January 2012)

Exhibit C: The portfolio with an allocation of 20% BXM and 80% S&P 500 had a return of 9.2% and standard deviation of 14.8%. For more analysis, please see our January

Enhanced Returns for Portfolios: Portfolios with small allocations to the futures-based indices and the VXTH had higher returns (and lower volatility) than the S&P 500. The annualized returns over the past 70 months were 2.4% for the S&P 500; 3.4% for a portfolio of 20% VXTH and 80% S&P 500; and 6.0% for a portfolio of 10% VTRsk (or 10% DyVX) and 90% S&P 500 (Exhibits I and O).

Higher Risk-adjusted Returns: Certain portfolios with the VXTH and the future-based indexes have had a higher Sortino Ratio than key stock indices over the last 70 months (Exhibits F and L).

This article analyzes five benchmarks that are designed to provide protection during declining equity markets (visit www.cboe.com/benchmarks and www.spvixviews.com/indices for more details).

Sources for all Exhibits on this page: Bloomberg, Ibbotson, ACG.

1 1 110

26

73

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111 0 00 0 0 1

24

103

137

40

2 0 000

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140

-24%

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0%

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6%

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%

-8%

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%

-4%

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0%

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4%

- 8%

8%

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%

12%

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%

16%

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%

20%

- 24

%

S&P 500CLL

CLL had only 1 month with losses of 8% or below.

10% BXM20% BXM

10% CLL20% CLL

S&P 500

MSCI EAFE

Russell 2000

S&P GSCI

6%

7%

8%

9%

10%

12% 14% 16% 18% 20% 22%Standard Deviation

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KEY TOOLS FOR HEDGING AND TAIL RISK MANAGEMENT

Ticker (Bloomberg)

Options or Futures Position(s) Hold stocks?

Price History Begins 2008 2009 2010 2011

CLL <Index>

Buys three-month out-of-the-money S&P 500 put options at 95% of the S&P 500 value. Sells one-month out-of-the-money S&P 500 call options at 110% of the S&P 500 value. S&P 500 June 1986 -23.6% 17.6% 4.1% -8.8%

VXTH <Index>

Buys one-month 30-delta VIX call options. The weight of the VIX calls in the portfolio varies at each roll depending on the perceived likelihood that a "black swan" event could occur in the near future.

S&P 500 March 2006 -19.3% 16.0% 21.1% 5.9%

SPVIXMTR <Index>

Buys a combination of VIX futures positions in order to reflect the expectations of the VIX Index level in 5 months. Some of the VIX futures are rolled daily in order to maintain a constant average weighted five-month term.

No stocks Dec. 2005 83.9% -23.6% -13.2% -7.6%

SPDVIXT <Index>

Buys a combination of VIX futures positions in order to reflect dynamic allocation between the S&P 500 Short-Term VIX Futures Index and S&P 500 Mid-Term VIX Futures Index. The rules-based allocation is done with the goal of aiming to lower the roll cost of investments linked to future implied volatility.

No stocks Dec. 2005 132.3% 0.7% 20.7% 8.8%

SPVXTRST <Index>

Calculated using a weight of 45% of 2x the S&P VIX Short-Term Futures Index and 55% of the Inverse S&P 500 Short-Term Futures Index. The goal of the index is to provide a long volatility exposure whose cost is partially or completely mitigated (due to negative roll yield) via a rebalanced short exposure.

No stocks Dec. 2005 174.3% -21.0% -3.0% 10.1%

SPTR <Index> None S&P 500 Jan. 1970 -37.0% 26.5% 15.1% 2.1%

Index

Annual % Return

CBOE S&P 500 95-110 Collar Index (CLL)

CBOE VIX Tail Hedge Index (VXTH)

S&P 500 VIX Mid-term Futures Index (VXMT)

S&P 500 Dynamic VIX Futures Index (DyVX)

S&P 500 VIX Futures Tail Risk Index - Short Term (VTRsk)

S&P 500 Index (Total Return)

2012 paper on index option writing at www.cboe.com/benchmarks


Exhibit D: Growth of $1 for VXTH, CLL and S&P 500 Indexes (April 2006 - January 2012)

Exhibit E: Histogram with Monthly Returns for VXTH and S&P 500 Indexes (April 2006 - January 2012)

Exhibit F: Metrics for Returns, Risk, and Risk-adjusted Returns (April 2006 - January 2012)

Exhibit G: Changes for 5 Indexes in Months in Which S&P 500 had Big Moves (More than 8.8%) (April 2006 - January 2012)

Exhibit H: “Over - Under” Chart with Returns Relative to S&P 500 (April 2006 - January 2012)

Exhibit I: Return and Volatility (April 2006 - January 2012)

TAIL RISK AND OPTIONS-BASED INDEXES - VXTH AND CLL (April 2006 - January 2012)

Exhibit D: The growth in the value of a dollar invested on March 31, 2006. The VXTH has outperformed the S&P 500 since inception.

Exhibit F: The VXTH index had risk-adjusted performance that was superior to that of the S&P 500 per metrics such as the Sortino Ratio, Sharpe Ratio and Jensen’s Alpha. Please note that the above indices had negative skewness, and the measures of risk-adjusted returns are imperfect when measuring non-normal distributions.

Exhibit H: The CLL cushion during declines is clear and compelling while the upside participation is somewhat moderated based on the underlying option exposures.

Exhibit I: The portfolio with an allocation of 20% VXTH and 80% S&P 500 had a return of 3.4% and standard deviation of 16.4%.

Exhibit E: Since April 2006 the VXTH had only 9 months with losses of 4% or below versus 13 months for the S&P 500. Conversely, the VXTH participated in 42 of the 43 positive months indicating upside participation as well as cushioning declines.

Exhibit G: The CLL and the VXTH provided a cushion during the worst three months for the S&P 500 and MSCI EAFE since April, 2006. The trade-off is reduced upside participation in the three best months.


CLL $0.96

VXTH $1.46

S&P 500 $1.15

$0.00

$0.20

$0.40

$0.60

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$1.00

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$1.60

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S&P 500VXTH

The worst monthly declines were down 15.1% for S&P 500

and down 10.7% for VXTH.

Oct 2008 -16.8% -20.2% -28.2% -3.8% 6.1%Feb 2009 -10.6% -10.3% -6.1% -5.4% -10.7%Sep 2008 -8.9% -14.5% -12.4% -6.8% -2.3%Sep 2010 8.9% 9.8% 8.5% 5.4% 8.1%Apr 2009 9.6% 12.8% -0.9% 5.6% 8.6%Oct 2011 10.9% 9.6% 9.7% 4.9% 9.1%

CLL VXTHS&P 500

MSCI EAFE

S&P GSCI

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-25 -20 -15 -10 -5 0 5 10 15 20 25S&P 500

CLL

VX

TH

CLLVXTH

In the 4th quarter, 2008, the VXTH increased 0.16% versus a decline of 22% for the S&P 500.

April 2006 - January 2012

%76.6%37.0-%15.4-%13.0-%73.2nruteRStandard Deviation 17.72% 21.41% 26.46% 11.45% 14.50%Beta vs. Market 1.00 1.11 0.83 0.60 0.59

14.0-92.0-47.0-6.0-36.0-ssenwekS92.06.0-68.179.069.0sisotruK

Sharpe Ratio 0.12 0.01 -0.1 -0.16 0.4Semi-Standard Deviation 13.5% 16.1% 20.3% 8.4% 10.8%Sortino Ratio (MAR=Cash Eq.) 0.30 0.13 -0.05 -0.01 0.78Jensen's Alpha vs. S&P 500 0.00% -2.15% -4.53% -3.12% 4.49%Correlation to S&P 500 1.00 0.92 0.55 0.92 0.72

VXTHS&P 500MSCI EAFE

S&P GSCI CLL

10% VXTH

20% VXTH

10% CLL20% CLL

S&P 500

MSCI EAFE

Russell 2000

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Exhibit J: Growth of $1 for VXMT, DyVX, VTRsk and S&P 500 Indexes (March 31, 2006 – January 31, 2012)

Exhibit K: Correlations of Weekly Changes for Select Indexes (April 7, 2006 - February 3, 2012)

Exhibit N: “Over – Under” Chart with Returns Relative to S&P 500 (April 2006 – January 2012)

Exhibit M: Changes for 5 Indexes in Months in Which S&P 500 had Big Moves (More Than 8.8%) (April 2006 – January 2012)

Exhibit L: Metrics for Returns, Risk, and Risk-adjusted Returns (April 2006 – January 2012)

Exhibit O: Returns and Volatility (April 2006 – January 2012)

DIVERSIFICATION AND VIX FUTURES INDEXES - VXMT, DyVX, AND VTRsk (April 2006 - January 2012)

Exhibit N: Allocating 10% to the VTRsk and DyVX provided cushion during declines while also participating in rising markets.

Exhibit L: A 10% allocation to the futures-based indices had risk-adjusted performance that was superior to that of the S&P 500 per metrics such as the Sortino Ratio, Sharpe Ratio and Jensen’s Alpha. Please note that the measures of risk-adjusted returns are imperfect when measuring non-normal distributions with negative skewness.

Exhibit O: The portfolio with an allocation of 10% VTRsk and 90% S&P 500 had a return of 6.0% and standard deviation of 13.4%.

Exhibit J: The three futures-based indices added value due to the fact that they all rose more than 80% in 2008 (see also the annual returns table Exhibit A).


S&P 500

VIX (Spot) VXMT DyVX VTRsk CLL VXTH

MSCI EAFE

S&P GSCI

S&P 500 1.00VIX (Spot) -0.72 1.00VXMT -0.70 0.73 1.00DyVX -0.63 0.53 0.83 1.00VTRsk -0.60 0.56 0.64 0.82 1.00CLL 0.89 -0.70 -0.68 -0.48 -0.42 1.00VXTH 0.87 -0.49 -0.53 -0.39 -0.33 0.83 1.00MSCI EAFE 0.84 -0.64 -0.64 -0.59 -0.61 0.77 0.69 1.00S&P GSCI 0.46 -0.30 -0.37 -0.36 -0.41 0.41 0.36 0.55 1.00

Exhibit K: The CLL and VXTH have a high correlation to the S&P 500 due to their stock exposure. All of the futures-based indices are negatively correlated to the stock indexes.

Exhibit M: The futures-based indices realized significant increases during September and October 2008. Conversely, they experienced double-digit declines during October 2011, a month when the S&P 500 rose 10.9%.

VXMT $1.53

DyVX $4.78

VTRsk $2.49

S&P 500 $1.15

$0.00

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S&P 500BarC Agg VXMT DyVX VTRsk

Oct. 2008 -16.8% -2.4% 44.0% 77.6% 162.5%Feb. 2009 -10.6% -0.4% 6.6% 3.2% -1.0%Sep. 2008 -8.9% -1.3% 13.3% 14.5% 12.1%Sep. 2010 8.9% 0.1% -5.8% 1.7% 1.5%Apr. 2009 9.6% 0.5% -7.2% -2.5% -7.0%Oct. 2011 10.9% 0.1% -16.0% -12.0% -28.9%

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&P

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&P

500

10% DyVX / 90% S&P 500 10% VTRsk / 90% S&P 500

In the 4th quarter of 2008, 10% VTRsk 90% S&P 500 declined 3.3% versus a decline of 22%

for the S&P 500.

%79.5%20.6%50.4%95.6%73.2nruteRStandard Deviation 17.72% 3.45% 13.51% 14.06% 13.36%Beta vs. Market 1.00 0.02 0.75 0.77 0.67

43.0-62.0-24.0-31.036.0-ssenwekS41.090.0-45.086.169.0sisotruK

Sharpe Ratio 0.12 1.34 0.23 0.36 0.37Semi-Standard Deviation 13.5% 2.4% 10.1% 10.3% 9.8%Sortino Ratio (MAR=Cash Eq.) 0.30 1.24 0.52 0.74 0.76Jensen's Alpha vs. S&P 500 0.00% 4.68% 1.51% 3.41% 3.50%Correlation to S&P 500 1.00 0.12 0.98 0.97 0.88

10%VTRsk/90%S&P

S&P 500 Bonds

10%VXMT/90% S&P

10%DyVX/90% S&P

10% VXMT

5% VXMT

10% DyVX

5% DyVX

S&P 500

10% VTRsk

5% VTRsk

2%

3%

4%

5%

6%

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10% 13% 16% 19%Standard Deviation

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Exhibit P: Pricing of VIX Spot Index and VIX Futures Exhibit Q: % Changes in October 2008

Exhibit S: VIX Index and the PUT and Call Volume for SPX and VIX Options (January 2007 - January 2012)

Exhibit R: Average Daily Volume for SPX Options, VIX Futures, and VIX Options (2004 – 2011)

PRICING OF VIX SPOT AND FUTURES

6.1%

44.0%

47.9%

52.0%

77.6%

162.5%

-28.2%

-20.2%

-3.8%

-16.8%

-50% 0% 50% 100% 150% 200%

S&P GSCI

MSCI EAFE

S&P 500

CLL

VXTH

VXMT

VIX Feb '09 Futures

VIX Index (spot)

DyVX

VTRsk

VIX Index80.86

0

30

60

90

3-Jan-2007 3-Jan-2008 2-Jan-2009 4-Jan-2010 3-Jan-2011 3-Jan-2012

Dai

ly C

losi

ng

Valu

e

Daily Volume -- 20-day Rolling Avg.

0

200,000

400,000

600,000

800,000

1,000,000

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

SPX Puts

SPX Calls

VIX Calls

VIX Puts

Exhibit S: As noted in Exhibit A on the first page, the CLL Index buys SPX puts and sells SPX calls, and the VXTH Index buys VIX calls. The index option volume often has spiked when the VIX Index rose sharply. The put-call ratios during the time period above were 1.68 for SPX options and 0.54 for VIX options.

Asset Consulting Group is an investment consulting firm which provides a full scope of investment advisory services to a select group of clients. The Chicago Board Options Exchange® (CBOE®) provided financial support for this paper. The CBOE S&P 500 indices are designed to represent proposed hypothetical strategies. The actual performance of investment vehicles such as mutual funds can have significant differences from the performance of the hypothetical indices. Like many passive indices, the indices do not take into account significant factors such as transaction costs and taxes. Investors attempting to replicate the indices should discuss with their advisors possible timing and liquidity issues. Past performance does not guarantee future results. Standard & Poor’s®, S&P®, and S&P 500® are registered trademarks of Standard & Poor’s Financial Services LLC and are licensed for use by the CBOE. CBOE and Chicago Board Options Exchange are registered trademarks of the CBOE, and the CBOE indices are servicemarks of the CBOE. CBOE calculates and disseminates the indices. The methodology of the indices are owned by CBOE and may be covered by one or more patents or pending patent applications. The information contained in this report is based on information obtained by ACG from sources that are believed to be reliable. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. The views expressed are those of Asset Consulting Group. They are subject to change at any time. These views do not necessarily reflect the opinions of any other firm. Copyright© 2012 Asset Consulting Group, LLC. All Rights Reserved.

Exhibit R: Our rough estimates for average daily notional dollar value of trading in 2011 (with a delta-adjustment of 0.5 for options, and a beta adjustment of 3.0 for VIX products) are more than $48 billion for SPX options, $3 billion for VIX futures, and $1 billion for VIX options. Assets in VIX-related exchange-traded products (ETPs) reached $5 billion in February 2012.

CAPACITY

Exhibit P: The VIX Spot Index is not an investable index. The VIX future returns will differ over time depending upon market expectations. Note the difference in the VIX Spot Index versus two futures expirations during the very volatile August to December, 2008 period. “Contango” occurs when the futures are trading higher than the spot index. “Backwardation” occurs when the futures trade lower than the spot index.

Exhibit Q: In October 2008 the VIX-based indexes rose, and the S&P 500 declined by 16.8%. The VIX-based indices can provide protective benefits during large drawdown periods. Note the difference in returns for the VIX spot index and VIX February 2009 futures. The VIX spot index often has bigger moves than the VIX futures, which reflect the future expected value of VIX.

Sources for all Exhibits on this page: Bloomberg, CBOE.

FEBRUARY 2012


KEY TOOLS FOR HEDGING AND TAIL RISK MANAGEMENT

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