How Risky Are the Options? A Comparison with the Underlying Stock Using MaxVaR as a Risk Measure

Saswat Patra and Malay Bhattacharyya
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Saswat Patra: S. P. Jain Institute of Management and Research, Mumbai 400058, India
Malay Bhattacharyya: Indian Institute of Management, Bangalore 560076, India

Risks, 2020, vol. 8, issue 3, 1-17

Abstract: This paper investigates the risk exposure for options and proposes MaxVaR as an alternative risk measure which captures the risk better than Value-at-Risk especially. While VaR is a measure of end-of-horizon risk, MaxVaR captures the interim risk exposure of a position or a portfolio. MaxVaR is a more stringent risk measure as it assesses the risk during the risk horizon. For a 30-day maturity option, we find that MaxVaR can be 40% higher than VaR at a 5% significance level. It highlights the importance of MaxVaR as a risk measure and shows that the risk is vastly underestimated when VaR is used as the measure for risk. The sensitivity of MaxVaR with respect to option characteristics like moneyness, time to maturity and risk horizons at different significance levels are observed. Further, interestingly enough we find that the MaxVar to VaR ratio is higher for stocks than the options and we can surmise that stock returns are more volatile than options. For robustness, the study is carried out under different distributional assumptions on residuals and for different stock index options.

Keywords: Pearson Type-IV; VaR; P& L; MaxVaR (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 K2 M2 M4 (search for similar items in EconPapers)
Date: 2020
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