Optimal Option Portfolio Strategies
Catholic University of Portugal (UCP)
New University of Lisbon - Nova School of Business and Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
AFA 2011 Denver Meetings Paper
Options should play an important role in asset allocation. They allow for kernel spanning and provide access to additional (priced) risk factors such as stochastic volatility and negative jumps. Unfortunately, traditional methods of asset allocation (e.g. mean-variance optimization) are not adequate for options because the distribution of returns is non-normal and the short sample of option returns available makes it difficult to estimate the distribution. We propose a method to optimize option portfolios that solves these limitations. An out-of-sample exercise is performed and we show that, even when transaction costs are incorporated, our portfolio strategy delivers an annualized Sharpe ratio of 0.59 between January 1996 and September 2008.
Number of Pages in PDF File: 38
Date posted: March 14, 2010 ; Last revised: April 11, 2011
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