Optimal Option Portfolio Strategies: Deepening the Puzzle of Index Option Mispricing
Jose Faias and
Pedro Santa-Clara
Journal of Financial and Quantitative Analysis, 2017, vol. 52, issue 1, 277-303
Abstract:
Traditional methods of asset allocation (such as mean–variance optimization) are not adequate for option portfolios because the distribution of returns is non-normal and the short sample of option returns available makes it difficult to estimate their distribution. We propose a method to optimize a portfolio of European options, held to maturity, with a myopic objective function that overcomes these limitations. In an out-of-sample exercise incorporating realistic transaction costs, the portfolio strategy delivers a Sharpe ratio of 0.82 with positive skewness. This performance is mostly obtained by exploiting mispricing between options and not by loading on jump or volatility risk premia.
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:cup:jfinqa:v:52:y:2017:i:01:p:277-303_00
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