Review of Derivatives Research

, Volume 16, Issue 1, pp 1–23 | Cite as

The performance of model based option trading strategies

Article

Abstract

This paper analyzes returns to trading strategies in options markets that exploit information given by a theoretical asset pricing model. We examine trading strategies in which a positive portfolio weight is assigned to assets which market prices exceed the price of a theoretical asset pricing model. We investigate portfolio rules which mimic standard mean-variance analysis is used to construct optimal model based portfolio weights. In essence, these portfolio rules allow estimation risk, as well as price risk to be approximately hedged. An empirical exercise shows that the portfolio rules give out-of-sample Sharpe ratios exceeding unity for S&P 500 options. Portfolio returns have no discernible correlation with systematic risk factors, which is troubling for traditional risk based asset pricing explanations.

Keywords

Dynamic trading Options returns Stochastic volatility Mean-variance 

JEL Classification

G1 G13 G17 

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Copyright information

© Springer Science+Business Media, LLC 2012

Authors and Affiliations

  1. 1.Department of FinanceWisconsin School of BusinessMadisonUSA

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