Enhancing Enterprise Value by Trading Options

Abstract

Investment activities are enhanced by a regular positioning in options. Results are presented for the S&P 500 index as the underlying asset. Two base activities, i) long the index and ii) a dynamic portfolio periodically rebalanced to a 60% equity stake, are considered for enhancement. In each case periodic targets are formulated that may involve nontraded strikes. Option positions are sought in traded strikes with a view towards minimizing the capital charge for the risk remaining after the hedge. The capital charge is based on the bid ask spread of a two price economy. Stress levels implicit in the two prices are taken to be consistent with risk neutral valuations falling within the spread. New positions always take account of legacy holdings from previous actions and all open positions are marked to market and delta hedged. The option enhanced businesses are valued using required returns reflecting premia for down and up side risk charges as embedded in the bid and ask prices of two price economies. Option positioning is observed to add market value.

Keywords: Conic Finance, Distorted Expectations, Variance Gamma Model, Probability Distortions Calibrated

JEL Classification: G10, G11, G13