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Relative Risk Perception and the Puzzle of Covered Call writing

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  • Siddiqi, Hammad

Abstract

Market professionals with decades of experience typically argue that a call option is a surrogate for the underlying asset, indicating that they perceive the risk of a call option as similar to the risk of the underlying asset. Experimental evidence also points to the same conclusion. Such relative risk perception is in sharp contrast with finance theory, which argues that only the absolute quantity of risk contained in a call option should matter for its price. I show that relative risk perception provides a potential explanation for the puzzling performance of covered call writing.

Suggested Citation

  • Siddiqi, Hammad, 2015. "Relative Risk Perception and the Puzzle of Covered Call writing," MPRA Paper 62763, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:62763
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    References listed on IDEAS

    as
    1. Siddiqi, Hammad, 2014. "Analogy Making and the Structure of Implied Volatility Skew," MPRA Paper 60921, University Library of Munich, Germany.
    2. Barberis, Nicholas & Thaler, Richard, 2003. "A survey of behavioral finance," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 18, pages 1053-1128, Elsevier.
    3. Siddiqi, Hammad, 2012. "The relevance of thinking-by-analogy for investors’ willingness-to-pay: An experimental study," Journal of Economic Psychology, Elsevier, vol. 33(1), pages 19-29.
    4. Siddiqi, Hammad, 2009. "Is the lure of choice reflected in market prices? Experimental evidence based on the 4-door Monty Hall problem," Journal of Economic Psychology, Elsevier, vol. 30(2), pages 203-215, April.
    5. Furnham, Adrian & Boo, Hua Chu, 2011. "A literature review of the anchoring effect," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 40(1), pages 35-42, February.
    6. Siddiqi, Hammad, 2015. "Analogy Based Valuation of Currency Options," MPRA Paper 62333, University Library of Munich, Germany.
    7. Merton, Robert C., 1976. "Option pricing when underlying stock returns are discontinuous," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 125-144.
    8. Siddiqi, Hammad, 2009. "Does Coarse Thinking Matter for Option Pricing? Evidence from an Experiment," MPRA Paper 13515, University Library of Munich, Germany.
    9. Siddiqi, Hammad, 2014. "Analogy Making and the Structure of Implied Volatility Skew," Risk and Sustainable Management Group Working Papers 187407, University of Queensland, School of Economics.
    10. Rötheli, Tobias F., 2010. "Causes of the financial crisis: Risk misperception, policy mistakes, and banks' bounded rationality," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 39(2), pages 119-126, April.
    11. repec:bla:jfinan:v:59:y:2004:i:2:p:711-753 is not listed on IDEAS
    12. Siddiqi, Hammad, 2015. "Analogy Based Valuation of Commodity Options," Risk and Sustainable Management Group Working Papers 197334, University of Queensland, School of Economics.
    13. Rockenbach, Bettina, 2004. "The behavioral relevance of mental accounting for the pricing of financial options," Journal of Economic Behavior & Organization, Elsevier, vol. 53(4), pages 513-527, April.
    14. Siddiqi, Hammad, 2015. "Analogy based Valuation of Commodity Options," MPRA Paper 61083, University Library of Munich, Germany.
    15. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Risk Perception; Relative Risk Perception; Covered Call Writing; Informational Efficiency; Anchoring; Behavioral Finance;
    All these keywords.

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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