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Option Strategies: Good Deals and Margin Calls

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  • Santa-Clara, Pedro
  • Saretto, Alessio

Abstract

We investigate the risk and return of a wide variety of trading strategies involving options on the S&P 500. We consider naked and covered positions, straddles, strangles, and calendar spreads, with different maturities and levels of moneyness. Overall, we ï¬ nd that strategies involving short positions in options generally compensate the investor with very high Sharpe ratios, which are statistically signiï¬ cant even after taking into account the non-normal distribution of returns. Furthermore, we ï¬ nd that the strategies’ returns are substantially higher than warranted by asset pricing models. We also ï¬ nd that the returns of the strategies could only be justiï¬ ed by jump risk if the probability of market crashes were implausibly higher than it has been historically. We conclude that the returns of option strategies constitute a very good deal. However, exploiting this good deal is extremely diffcult. We ï¬ nd that trading costs and margin requirements severely condition the implementation of option strategies. Margin calls force investors out of a trade precisely when it is losing money. Taking margin calls into account turns the Sharpe ratio of some of the best strategies negative.

Suggested Citation

  • Santa-Clara, Pedro & Saretto, Alessio, 2004. "Option Strategies: Good Deals and Margin Calls," University of California at Los Angeles, Anderson Graduate School of Management qt0499w44p, Anderson Graduate School of Management, UCLA.
  • Handle: RePEc:cdl:anderf:qt0499w44p
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    Cited by:

    1. Jensen, Mads Vestergaard & Pedersen, Lasse Heje, 2016. "Early option exercise: Never say never," Journal of Financial Economics, Elsevier, vol. 121(2), pages 278-299.
    2. Peter Christoffersen & Mathieu Fournier & Kris Jacobs & Mehdi Karoui, 2015. "Option-Based Estimation of the Price of Co-Skewness and Co-Kurtosis Risk," CREATES Research Papers 2015-54, Department of Economics and Business Economics, Aarhus University.
    3. repec:eee:finmar:v:36:y:2017:i:c:p:91-114 is not listed on IDEAS
    4. George M. Constantinides & Michal Czerwonko & Stylianos Perrakis, 2017. "Mispriced Index Option Portfolios," NBER Working Papers 23708, National Bureau of Economic Research, Inc.
    5. Ghada Ali TIMRAZ & Faris Nasif AL-SHUBIRI, 2012. "The Impact Of Stock Options Trading On The Market Value Of Companies Listed In Kuwait Stock Exchange," Business Excellence and Management, Faculty of Management, Academy of Economic Studies, Bucharest, Romania, vol. 2(3), pages 63-76, September.
    6. Byun, Suk Joon & Jeon, Byoung Hyun & Min, Byungsun & Yoon, Sun-Joong, 2015. "The role of the variance premium in Jump-GARCH option pricing models," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 38-56.
    7. Bakshi, Gurdip & Madan, Dilip & Panayotov, George, 2010. "Returns of claims on the upside and the viability of U-shaped pricing kernels," Journal of Financial Economics, Elsevier, vol. 97(1), pages 130-154, July.
    8. Shackleton, Mark B. & Voukelatos, Nikolaos, 2013. "Hedging efficiency in the Greek options market before and after the financial crisis of 2008," Journal of Multinational Financial Management, Elsevier, vol. 23(1), pages 1-18.
    9. Bjørn Eraker, 2013. "The performance of model based option trading strategies," Review of Derivatives Research, Springer, vol. 16(1), pages 1-23, April.
    10. Andrada-Félix, Julián & Fernández-Rodríguez, Fernando & Fuertes, Ana-Maria, 2016. "Combining nearest neighbor predictions and model-based predictions of realized variance: Does it pay?," International Journal of Forecasting, Elsevier, vol. 32(3), pages 695-715.
    11. Alfredo Ibáñez, 2008. "The cross-section of average delta-hedge option returns under stochastic volatility," Review of Derivatives Research, Springer, vol. 11(3), pages 205-244, October.
    12. Andrea Frazzini & Lasse H. Pedersen, 2012. "Embedded Leverage," NBER Working Papers 18558, National Bureau of Economic Research, Inc.
    13. Benzoni, Luca & Collin-Dufresne, Pierre & Goldstein, Robert S., 2011. "Explaining asset pricing puzzles associated with the 1987 market crash," Journal of Financial Economics, Elsevier, vol. 101(3), pages 552-573, September.
    14. Jakub W. Jurek & Erik Stafford, 2011. "The Cost of Capital for Alternative Investments," Harvard Business School Working Papers 12-013, Harvard Business School.
    15. Goyal, Amit & Saretto, Alessio, 2009. "Cross-section of option returns and volatility," Journal of Financial Economics, Elsevier, vol. 94(2), pages 310-326, November.
    16. Amira, Khaled & Bennour, Khaled, 2010. "Borrowing Constraint and the Effect of Option Introduction," MPRA Paper 26440, University Library of Munich, Germany.
    17. Longarela, Iñaki R. & Mayoral, Silvia, 2015. "Quote inefficiency in options markets," Journal of Banking & Finance, Elsevier, vol. 55(C), pages 23-36.
    18. Fahlenbrach, Rüdiger & Sandås, Patrik, 2010. "Does information drive trading in option strategies?," Journal of Banking & Finance, Elsevier, vol. 34(10), pages 2370-2385, October.
    19. Duyvesteyn, Johan & de Zwart, Gerben, 2015. "Riding the swaption curve," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 57-75.
    20. Leippold, Markus & Su, Lujing, 2015. "Collateral smile," Journal of Banking & Finance, Elsevier, vol. 58(C), pages 15-28.
    21. repec:wsi:ijtafx:v:10:y:2007:i:07:n:s0219024907004585 is not listed on IDEAS
    22. Lai, Ya-Wen, 2017. "Macroeconomic factors and index option returns," International Review of Economics & Finance, Elsevier, vol. 48(C), pages 452-477.
    23. Jose Faias & Pedro Santa-Clara, 2011. "Optimal Option Portfolio Strategies," EcoMod2011 3041, EcoMod.
    24. Aramonte, Sirio, 2014. "Macroeconomic uncertainty and the cross-section of option returns," Journal of Financial Markets, Elsevier, vol. 21(C), pages 25-49.

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