The Returns and Risk of Alternative Call Option Portfolio Investment Strategies

Abstract

Since the opening of the Chicago Board Options Exchange in April 1973, the options market has been the fastest growing segment of the securities industry. With this rapid growth has come controversy over the purpose served by options in the capital markets. As we see it, the principal function of options is to provide a significant expansion of the patterns of portfolio returns available to investors. Such expansions make investors better off and add to the liquidity and efficiency of the capital markets. For investors to benefit from the additional investment opportunities provided by options, they must be informed as to the return characteristics of various option strategies. The option exchanges, however, have been in existence for only a short period of time, and therefore firsthand experience in trading of options in organized markets over a number of market cycles does not exist. As a partial substitute for this experience, numerous articles and books have been written, and advisory services have been The combination of a short trading history and inadequate analyses has generated a variety of myths about the returns and risks of option trading. Although it is possible to give a qualitative description of the return patterns associated with various option strategies for single option-stock positions, it is difficult to give a similar description for portfolio strategies involving options and stock. This paper provides analyses and empirical evidence of the return patterns on portfolio strategies involving options over a significant period of time. Two important strategies, the fully covered writing strategy and the options/paper -buying strategy are analyzed in this study. * This research was financed in part by grants from Donaldson, Lufkin & Jenrette, New York; the Center for Research in Security Prices, University of Chicago; and the National Science Foundation. We thank Merton Miller for his extensive comments on an earlier draft.