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Performance expectations of basic options strategies may be different than you think

Author

Listed:
  • Steven P. Clark

    (University of North Carolina at Charlotte
    Horizon Investments, LLC)

  • Mike Dickson

    (Horizon Investments, LLC)

Abstract

There is much empirical evidence for the existence of a negative volatility risk premium. We consider how the volatility risk premium affects the returns of portfolios implementing seven popular option strategies. We find that option selling generates substantial excess return as well as risk mitigation by providing short exposure to the volatility risk premium. Net option buying is able to protect against extreme losses; however, these losses are very infrequent and short lived. Even during these periods, the long net exposure to the volatility risk premium erodes protection as the depth and duration of the losses persist.

Suggested Citation

  • Steven P. Clark & Mike Dickson, 2019. "Performance expectations of basic options strategies may be different than you think," Journal of Asset Management, Palgrave Macmillan, vol. 20(2), pages 91-102, March.
    • Handle: RePEc:pal:assmgt:v:20:y:2019:i:2:d:10.1057_s41260-019-00111-x
    DOI: 10.1057/s41260-019-00111-x
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    References listed on IDEAS

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    1. Tim Bollerslev & George Tauchen & Hao Zhou, 2009. "Expected Stock Returns and Variance Risk Premia," The Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4463-4492, November.
    2. Glosten, Lawrence R & Jagannathan, Ravi & Runkle, David E, 1993. "On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks," Journal of Finance, American Finance Association, vol. 48(5), pages 1779-1801, December.
    3. Gurdip Bakshi & Nikunj Kapadia, 2003. "Delta-Hedged Gains and the Negative Market Volatility Risk Premium," The Review of Financial Studies, Society for Financial Studies, vol. 16(2), pages 527-566.
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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. Lingling Xu & Hongjie Zhang & Fu Lee Wang, 2023. "Pricing of Arithmetic Average Asian Option by Combining Variance Reduction and Quasi-Monte Carlo Method," Mathematics, MDPI, vol. 11(3), pages 1-14, January.
    3. Dörries, Julian & Korn, Olaf & Power, Gabriel J., 2023. "How should the long-term investor harvest variance risk premiums?," CFR Working Papers 23-06, University of Cologne, Centre for Financial Research (CFR).

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