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The performance of model based option trading strategies

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  • Bjørn Eraker

Abstract

This paper analyzes returns to trading strategies in options markets that exploit information given by a theoretical asset pricing model. We examine trading strategies in which a positive portfolio weight is assigned to assets which market prices exceed the price of a theoretical asset pricing model. We investigate portfolio rules which mimic standard mean-variance analysis is used to construct optimal model based portfolio weights. In essence, these portfolio rules allow estimation risk, as well as price risk to be approximately hedged. An empirical exercise shows that the portfolio rules give out-of-sample Sharpe ratios exceeding unity for S&P 500 options. Portfolio returns have no discernible correlation with systematic risk factors, which is troubling for traditional risk based asset pricing explanations. Copyright Springer Science+Business Media, LLC 2013

Suggested Citation

  • Bjørn Eraker, 2013. "The performance of model based option trading strategies," Review of Derivatives Research, Springer, vol. 16(1), pages 1-23, April.
    • Handle: RePEc:kap:revdev:v:16:y:2013:i:1:p:1-23
    DOI: 10.1007/s11147-012-9079-8
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    References listed on IDEAS

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    1. Bjørn Eraker & Michael Johannes & Nicholas Polson, 2003. "The Impact of Jumps in Volatility and Returns," Journal of Finance, American Finance Association, vol. 58(3), pages 1269-1300, June.
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    Cited by:

    1. Jonathan Raimana Chan & Thomas Huckle & Antoine Jacquier & Aitor Muguruza, 2021. "Portfolio optimisation with options," Papers 2111.12658, arXiv.org, revised Sep 2024.
    2. Zhu, Shushang & Zhu, Wei & Pei, Xi & Cui, Xueting, 2020. "Hedging crash risk in optimal portfolio selection," Journal of Banking & Finance, Elsevier, vol. 119(C).
    3. Eraker, Bjørn & Wu, Yue, 2017. "Explaining the negative returns to volatility claims: An equilibrium approach," Journal of Financial Economics, Elsevier, vol. 125(1), pages 72-98.
    4. Francesco Carlier, 2021. "A Simple Options Trading Strategy based on Technical Indicators," International Journal of Economics and Financial Issues, Econjournals, vol. 11(2), pages 88-91.

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    More about this item

    Keywords

    Dynamic trading; Options returns; Stochastic volatility; Mean-variance; G1; G13; G17;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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