Write on the Money?

35 Pages Posted: 12 Jul 2016 Last revised: 20 Jul 2016

See all articles by Lew Burton

Lew Burton

University of Massachusetts Amherst

Nikunj Kapadia

University of Massachusetts Amherst - Department of Finance

Brandon Sneider

University of Massachusetts Amherst - Department of Finance

Date Written: July 10, 2016

Abstract

An unusual combination of assumptions - markets have frictions, but nonetheless are price efficient - is required to justify the generic buy-write strategy. In theory, a buy-write strategy allows investors to earn the variance risk premium (VRP) when they cannot access the variance swap market because of market frictions. But whether the strategy earns the expected VRP is contingent on markets being efficient. We show that the performance of the generic buy-write strategy that writes at-the-money options deteriorates rapidly in the presence of short-lived anomalies. Empirically, an alternative strategy that is designed to protect against market reversals outperforms the generic strategy. Our analysis provides a potential explanation of why, in practice, these popular option-write strategies earn but a fraction of the expected variance risk premium.

Keywords: Variance Risk Premium, Buy-Write, Covered Call, Market Anomalies

JEL Classification: G12, G13

Suggested Citation

Burton, Lew and Kapadia, Nikunj and Sneider, Brandon, Write on the Money? (July 10, 2016). Available at SSRN: https://ssrn.com/abstract=2807556 or http://dx.doi.org/10.2139/ssrn.2807556

Lew Burton

University of Massachusetts Amherst ( email )

Amherst, MA 01003
United States

Nikunj Kapadia (Contact Author)

University of Massachusetts Amherst - Department of Finance ( email )

Amherst, MA 01003
United States
413-545-5643 (Phone)
413-545-5600 (Fax)

HOME PAGE: http://www-unix.oit.umass.edu/~nkapadia/

Brandon Sneider

University of Massachusetts Amherst - Department of Finance ( email )

Amherst, MA 01003
United States

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