Optimal Option Portfolio Strategies

38 Pages Posted: 14 Mar 2010 Last revised: 11 Apr 2011

See all articles by José Afonso Faias

José Afonso Faias

Catholic University of Portugal (UCP)

Pedro Santa-Clara

New University of Lisbon - Nova School of Business and Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: January 2011

Abstract

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.

Suggested Citation

Faias, José and Santa-Clara, Pedro, Optimal Option Portfolio Strategies (January 2011). AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1569380 or http://dx.doi.org/10.2139/ssrn.1569380

José Faias (Contact Author)

Catholic University of Portugal (UCP) ( email )

Palma de Cima
Lisboa, 1649-023
Portugal

Pedro Santa-Clara

New University of Lisbon - Nova School of Business and Economics ( email )

Lisbon
Portugal

HOME PAGE: http://docentes.fe.unl.pt/~psc/

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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