The Buy-Write Strategy, Index Investment, and the Efficient Market Hypothesis: More Australian Evidence

Abstract

One of the most basic and most popular options strategies is the “buy-write,” in which an underlying asset is purchased and a call option is written against it. This trade gives up the possibility of very large returns in a strong rally in order to gain an extra profit in a moderate rally and some compensation against losses on the downside. In theory, the reduction in risk exposure should lead to lower expected returns, but O’Connell and O’Grady find that it does not, at least not in Australia. They find that over more than 20 years, the strategy of going long the S&P/ASX Buy-Write Index and short calls on the index would have outperformed both a straight long index position and an investment in essentially risk-free 90-day bank bills. Performance criteria include mean return, standard deviation, and downside volatility. The authors consider their evidence suggestive of market inefficiency, but not definitive proof of it.