Portfolio Policies with Stock Options

40 Pages Posted: 4 Mar 2008 Last revised: 15 Feb 2009

See all articles by Yuliya Plyakha

Yuliya Plyakha

Universite du Luxembourg - School of Finance

Grigory Vilkov

Frankfurt School of Finance & Management

Date Written: May 8, 2008

Abstract

We study the partial equilibrium portfolio optimization problem for a myopic CRRA investor who can trade options on individual stocks. Applying the parametric portfolio approach of Brandt, Santa-Clara, and Valkanov (forthcoming) to derivatives, we show that options characteristics (such as implied volatility and IV smile skew) convey information about the mispricing in the option portfolios. We take the data on all US-traded options to build characteristic-based factor portfolios of options. An investor uses them in addition to the market portfolio and Fama and French (1992) factors in her utility maximization. Surprisingly, portfolios based on the IV smile skew turn out to be less important than IV-based portfolios, and factor portfolios from call options are in general more interesting for an investor than the factors from puts. Market frictions in the form of stock shortsale constraints are compensated by the use of options, and having options with no stock shortsales allowed may be better than having only stocks with shortsales permitted. Monthly rebalancing leads to extreme transaction costs for an investor facing the full bid-ask spread, providing limits to arbitrage interpretation of the documented mispricing in the option portfolios.

Keywords: stock options, portfolio analysis, hedge fund policy, implied volatility, skew risk

JEL Classification: C21, G13, G14

Suggested Citation

Plyakha, Yuliya and Vilkov, Grigory, Portfolio Policies with Stock Options (May 8, 2008). Available at SSRN: https://ssrn.com/abstract=1101305 or http://dx.doi.org/10.2139/ssrn.1101305

Yuliya Plyakha

Universite du Luxembourg - School of Finance ( email )

4 Rue Albert Borschette
Luxembourg, L-1246
Luxembourg

Grigory Vilkov (Contact Author)

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

HOME PAGE: http://www.vilkov.net

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