Blog - Investing Notes

Blog Synthesis: Equity Options

Can investors/speculators use equity options to boost return through buying and selling leverage (calls), and/or buying and selling insurance (puts)? If so, which strategies work best? Here is a listing of past blog entries related to trading equity options:

Do Informed Traders Tip Their Hands Via Option Purchases? ...evidence supports beliefs that informed traders distort the relationship between the prices for put and call options on individual stocks and that others may be able to exploit these distortions. Relatively expensive calls (puts) predict stock outperformance (underperformance).

The Volatility Risk Premium and De-biased Equity Option Returns ...speculators may be able to exploit the volatility risk premium by selling short-term deep out-of-the-money put options and all maturities of deep out-of-the-money call options on the broad stock market, especially during periods of high volatility.

Best-of-Breed for Get-Rich-Quick Option Tips ...The unreal deal, as found in the cyber-alleys off Wall Street...

Consistently Expensive Types of Equity Options ...options for stock indexes are expensive compared to options for the average individual stock, and options for small and value stocks are expensive compared to options for large and growth stocks. Hedge portfolios exploiting these differences may offer abnormal returns.

Strategies for Investing in Options of Individual Stocks ...investors are willing to pay a premium to protect themselves from crashes in individual stocks. Systematically selling puts on individual stocks, with sufficient leverage, can enhance equity portfolio performance.

Is 40% Per Month Shorting Index Puts a Fair Return? ...investors are willing to pay very high premiums, perhaps irrationally high, to insure against large losses in their stock portfolios. Sellers of this insurance can earn high average returns.

Abnormal Returns from Selling Index Put Options? ...a strategy of systematically selling index put options generates on average large abnormal returns but suffers occasional very large setbacks when the underlying index plunges.

Outperformance from Mechanically Selling Covered Calls on a Stock Index ...a strategy of mechanically selling one-month-to-expiration covered calls on the Russell 2000 index consistently outperforms the index based on risk-adjusted (but not raw) returns.

Good Deals in Broad Market Index Options? ...investors/traders are generally willing to overpay for insurance and leverage via options, but only the market makers can consistently exploit this willingness.

Making Money with Options Based on Superior Volatility Forecasts ...a market inefficiency with respect to volatility expectations for individual stocks may provide a means to beat the market by using options to trade volatility.

The Options Trading Landscape ...investors/traders write (sell) more options than they purchase and deal much more in calls than in puts. Call writing is mostly hedging, while call purchasing and put writing are mostly speculations on stock prices.

Sell Risk to Growth Investors and Buy It from Value Investors? ...value investors are generally risk avoiders, and growth investors are typically risk seekers. Buying risk from one group and selling it to the other may be profitable.

Measuring Investor/Trader Risk Aversion ...when investors/traders are depressed, as measured by the gap between implied volatility and historical volatility, so are stock prices.

Can Individual Investors Enhance Returns with Options? ...investing in options as a marginal enhancement to a buy-and-hold approach can improve returns and Sharpe ratios, but only if the options positions are small compared to overall portfolio size.

In summary, recent research indicates that individual investors/traders can on average enhance returns by selling options, as long as the options positions are small compared to their overall portfolios. Speculators may be able to exploit the volatility risk premium by systematically selling equity options more aggressively.