Option-Based Equity Strategies
28 Pages Posted: 9 Mar 2018
Date Written: March 5, 2018
Options are derivatives contracts that provide investors the flexibility of constructing expected payoffs for their investment strategies. Option-based equity strategies incorporate the use of options with long positions in equities to achieve objectives such as drawdown protection and higher income. While the range of strategies available is wide, most strategies can be classified as insurance buying (net long options/volatility) or insurance selling (net short options/volatility).
The existence of the Volatility Risk Premium, a market anomaly that causes put options to be overpriced relative to what an efficient pricing model expects, has led to an empirical outperformance of insurance selling strategies relative to insurance buying strategies.
This paper explores whether, and to what extent, option-based equity strategies should be considered within the long-only equity investing toolkit, given that equity risk is still the main driver of returns for most of these strategies. It is important to note that while option-based strategies seek to design favorable payoffs, all such strategies involve trade-offs between expected payoffs and cost.
Keywords: options, equities, put write, buy write, tail risk, insurance, hedging, "defensive equity"
Suggested Citation: Suggested Citation