S&P GSCI Covered Call Select could be used for notes, S&P analyst says

By Emma Trincal

New York, Oct. 7 - Standard & Poor's is paving the way for new structured products and exchange-traded notes with the launch of a new index derived from the S&P GSCI, Michael G. McGlone, senior director of commodity indexing at Standard & Poor's, told Prospect News.

"This index has the potential to be a real benchmark," he said.

S&P announced the launch of the S&P GSCI Covered Call Select index to simulate a covered call strategy on commodities within the S&P GSCI that have active options markets.

"This is the first covered call index in the commodity space," McGlone said. "As a new benchmark, this index could be used as the basis of future products, even for ETNs. That would be a good target for it."

Utilizing a covered call in a portfolio is a "very widely used" options strategy, said McGlone. It is employed to increase income through the collection of a premium from the sale of a call option.

Liquidity filter

McGlone said that the new index methodology first applies a liquidity filter.

This step consists of picking out of the 24 constituent commodities of the S&P GSCI those that have the most actively traded options.

A commodity that fits the criterion for liquidity would need to have an option trading volume of at least 10% of the volume of the underlying future contract, McGlone explained.

Ten commodities are then included in the 2010 S&P GSCI Covered Call Select index. These are coffee, corn, cotton, crude oil, gold, natural gas, silver, soybeans, sugar and wheat, according to a news release.

Covered call

The index replicates a strategy that takes long positions in futures contracts while writing out-of-the-money calls on the underlying contracts. Positions are not held to maturity but rolled into the next contract, McGlone explained.

A call option is "out of the money" when its strike price is above the market price of the underlying asset.

"When you write the out-of-the-money while rolling into your next futures contract, you have the potential to enhance your return, and that's what the strategy is trying to do: add some potential income to the index," he said.

Each commodity included in the index has a separate covered call index, reflecting an investment in the rolling active futures contract and the systematic selling of out-of-the-money calls, according to the release.

The 10 indexes are included in the composite index on an equally weighted basis.

"[The index] is designed to target lower volatility exposure to commodities, alleviate some of the potential drag on returns from rolling into contango and seek potential income in a very low fixed rate income environment," McGlone said in the news release.

The sale of the call options provides the premium - in other words, some return - as well as a hedge for the long exposure to the commodities futures contracts, he explained.

"There are no indexes that capture this type of strategy in the commodities market," McGlone told Prospect News.

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