Option-Writing Strategies in a Low-Volatility Framework
Posted: 8 May 2014 Last revised: 7 Feb 2017
Date Written: April 30, 2014
Covered call buy-write strategies have risk-return profiles that are similar to those of low volatility equity portfolios, and both approaches appear to extract return premium from investors with leverage constraints and a preference for lottery-like bets. We analyzed simulated long-term (1996-2012) returns of buy-write strategies using one-month and three-month call options on the S&P 500 Index, across a range of strike levels, with monthly and quarterly rebalancing. We found that monthly rebalancing of three-month options generated the most favorable results. We also found that the improvement in risk-adjusted performance achieved with buy-write strategies comes from the skewness premium earned for accepting exposure to the tail risk of substantial losses. In addition, we determined that, due to differences in factor loadings, a buy-write strategy would likely serve well to diversify the risks of a low volatility equity portfolio.
Keywords: Low volatility, covered call, preference for lottery, leverage constraints, skewness premium
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