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Technical Note—Options Portfolio Selection

Author

Listed:
  • Paolo Guasoni

    (School of Mathematical Sciences, Dublin City University, Glasnevin, Dublin 9, Ireland; Department of Mathematics and Statistics, Boston University, Boston, Massachusetts 02215)

  • Eberhard Mayerhofer

    (Department of Mathematics and Statistics, University of Limerick, Limerick V94T9PX, Ireland)

Abstract

We develop a new method to optimize portfolios of options in a market where European calls and puts are available with many exercise prices for each of several potentially correlated underlying assets. We identify the combination of asset-specific option payoffs that maximizes the Sharpe ratio of the overall portfolio: such payoffs form the unique solution to a system of integral equations, which reduces to a linear matrix equation under discrete representations of the underlying probabilities. Even when risk-neutral volatilities are all higher than physical volatilities, it can be optimal to sell options on some assets while buying options on other assets, for which the positive hedging demand outweighs negative demand stemming from asset-specific returns.

Suggested Citation

  • Paolo Guasoni & Eberhard Mayerhofer, 2020. "Technical Note—Options Portfolio Selection," Operations Research, INFORMS, vol. 68(3), pages 733-740, May.
    • Handle: RePEc:inm:oropre:v:68:y:2020:i:3:p:733-740
    DOI: 10.1287/opre.2019.1925
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    References listed on IDEAS

    as
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    3. Breeden, Douglas T & Litzenberger, Robert H, 1978. "Prices of State-contingent Claims Implicit in Option Prices," The Journal of Business, University of Chicago Press, vol. 51(4), pages 621-651, October.
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    Cited by:

    1. Fengmin Xu & Jieao Ma, 2023. "Intelligent option portfolio model with perspective of shadow price and risk-free profit," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 9(1), pages 1-28, December.
    2. Eberhard Mayerhofer, 2024. "The Smirnov Property for Weighted Lebesgue Spaces," Mathematics, MDPI, vol. 12(19), pages 1-16, October.

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