Option Writing Strategies in a Low Volatility Framework

  • Donald X. He Allianz Global Investors US LLC; University of California, Los Angeles (UCLA) - Anderson School of Management
  • Jason C. Hsu Research Affiliates, LLC; University of California, Los Angeles - Anderson School of Business
  • Neil Rue Pension Consulting Alliance

    Low vola outperformed

    The last decade has represented a period of reorientation towards low volatility strategies for the investment community. An anomaly has been generated: portfolios of low beta stocks have outperformed by far the higher beta stocks. Different studies tried to explain this anomaly, focusing almost totally on equities, while practitioners added covered call option strategies to their low volatility offerings, which may be systematically overpriced.

    Covered call writing, often referred to as a buy-write strategy, represents a way for investors to decrease their risk or to enhance their return by selling call options against their stock holdings. Buy write strategies tend to have similar risk-return ratio as low volatility equity portfolios, but prior research on low volatility investing hasn’t included buy-write strategies.

    An extensive research Option Writing Strategies In A Low Volatility Framework has been made on simulated long term (1996 – 2012) returns of buy-write strategies using one and three months call options on the Standard &Poor’s 500 Index, across different strike levels, with regular rebalancing. It compared different buy-write strategies based on writing call options with different maturities and rebalancing frequencies, it also compared risk and return profiles of buy write strategies with those of low volatility equity strategies and provided empirical support for the preference-for lottery and leverage constraint hypotheses.

    writing call options, short calls

    The main conclusions of this study were that monthly rebalancing of three-month options generated best results and the risk-adjusted performance improvement generated by different buy-write strategies comes from the skewness premium received for taking the risk of substantial losses. Also, a buy-write strategy could be used to diversify the risks of a low volatility equity portfolio, because of the differences in factor loadings.

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    writing covered calls