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Portfolio optimization with covered calls

Author

Listed:
  • Mauricio Diaz

    (University of Toronto)

  • Roy H. Kwon

    (University of Toronto)

Abstract

Covered calls are traditionally formed as an overlay on an existing portfolio. Our analysis suggests that covered calls formed in two steps by first optimizing underlying equity positions and then selecting call overwriting weights are not risk-return optimal in general. We introduce an optimization framework which simultaneously selects underlying asset positions and call options to sell to form risk-return optimal covered call portfolios. Call option market prices form a critical part of the expected return and risk expressions. Variance of the return, semivariance of the return, and conditional value-at-risk are used as risk measures. The model was first tested by forming covered call portfolios composed of three indices and then by forming portfolios using 92 U.S. equities. We find that selling call options not only reduces risk, but when selected optimally can also benefit the expected return.

Suggested Citation

  • Mauricio Diaz & Roy H. Kwon, 2019. "Portfolio optimization with covered calls," Journal of Asset Management, Palgrave Macmillan, vol. 20(1), pages 38-53, February.
    • Handle: RePEc:pal:assmgt:v:20:y:2019:i:1:d:10.1057_s41260-018-00106-0
    DOI: 10.1057/s41260-018-00106-0
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    References listed on IDEAS

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    1. Michaud, Richard O. & Michaud, Robert O., 2008. "Efficient Asset Management: A Practical Guide to Stock Portfolio Optimization and Asset Allocation," OUP Catalogue, Oxford University Press, edition 2, number 9780195331912.
    2. Zymler, Steve & Rustem, Berç & Kuhn, Daniel, 2011. "Robust portfolio optimization with derivative insurance guarantees," European Journal of Operational Research, Elsevier, vol. 210(2), pages 410-424, April.
    3. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
    4. Alexander, S. & Coleman, T.F. & Li, Y., 2006. "Minimizing CVaR and VaR for a portfolio of derivatives," Journal of Banking & Finance, Elsevier, vol. 30(2), pages 583-605, February.
    5. J. Board & C. Sutcliffe & E. Patrinos, 2000. "The performance of covered calls," The European Journal of Finance, Taylor & Francis Journals, vol. 6(1), pages 1-17.
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    Cited by:

    1. Pratish Patel & Andrew Raquel & Savannah Chadwick, 2024. "The cash-secured put-write strategy and the variance risk premium," Journal of Asset Management, Palgrave Macmillan, vol. 25(1), pages 31-50, February.
    2. Maria Elena De Giuli & Dennis Montagna & Federica Naldi & Alessandra Tanda, 2019. "Enhance and Protect Portfolio Returns: A Dynamic Put Spread Optimization," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 11(12), pages 1-66, December.

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