A Margin Requirement Based Return Calculation for Portfolios of Short Option Positions

Abstract:     
Short option positions carry significant risk of losses well in excess of 100% of the initial option price. Margin requirements associated with such positions are therefore considerable. I develop a methodology for calculating margin requirement-based short option portfolio returns. Accounting for margin requirements reduces the returns of simple short option strategies by up to 92% compared to the price return. In long/short portfolio analyses, use of margin requirement returns necessitates additional methodological adjustments to ensure that unwanted volatility risk is properly hedged. The result is a portfolio return that more accurately represents the return realized by investors, and increased power to detect cross-sectional patterns in option returns.

Number of Pages in PDF File: 80

Keywords: Margin Requirements, Short Option Returns, Volatility Risk Premium

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