Options Portfolio Selection with Position Limits
33 Pages Posted: 5 Dec 2022
Date Written: November 28, 2022
This paper examines the performance from 1996 to 2020 of mean-variance efficient portfolios of monthly options with all available strikes on each of the S&P 500, Nasdaq 100, and Dow Jones indexes, using a constrained optimization approach that incorporates position limits, transaction costs, and volatility persistence. The Sharpe ratios of index-neutral strategies is between one and two for the S&P 500 and Nasdaq 100, but less than half for the Dow Jones. Constraining portfolios to be solvent on all past index' returns reduces Sharpe ratios by a third in the S&P 500 and Nasdaq 100 and by two thirds in the Dow Jones. All strategies suffer significant losses from the coronavirus shock of 2020, underscoring their vulnerability to rare events.
Keywords: options, portfolio choice, position limits, quadratic optimization
JEL Classification: G11, G12
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