The "academic" papers that I found purely observe that the realized volatility has been lower than the implied volatility in recent history. I was not able to find an explanation though; and like I said, the options market is not that old, and some experts speculate that this pattern might reverse.There's quite a bit of academic work indicating selling options is profitable due to consistent over estimation of actualized volatility...less the geek speak, people pay too much for their stock insurance. I don't claim to know the future, but I would be very surprised to see option selling profitability go away totally. Options are insurance or speculative leverage period. Likely there will always be entities in the market who want to transfer risk so I don't see that element not being somewhat profitable over the long haul. The day it does, is the day options markets cease to exist. No one is going to bare risk for free. However, like a lot things in markets, they have become much more efficient and therefore less profitable.Time decay means nothing; it's nothing but a mathematical construct with one variable (price of underlying) held constant.The author of this post specifically asked about selling options. I agree options are net-net zero sum. However, for selling options there is a time decay advantage and/or volatility decay premium(s). Overall, options selling (when done appropriately at the right level of risk) is negative skewed with a positive expected return.
Disclosure: I have an options selling overlay for my portfolio.
What makes you believe that selling options has positive net return in the long run? It did so the last 20 years or so; but there is no explanation that I am aware of, and I read some articles that say it might reverse in the future.
Is there a risk based explanation, like tail risk or options jump risk that didn't materialize the last 20 years? If so, the expected returns might still be zero.
I have the same question as the OP: What is the expected options return of selling volatility? If it is positive, is the risk correlated with the stock market? Are there any academic studies?
The historical returns were positive for call options writing too, which cannot be interpreted as "insurance" against the stock market risk.
I have a hard time even interpreting put option writing as stock market insurance; each option has a specific negative delta, that neutralizes some of your long stock position if you have any; you could neutralize your long stock and reduce your delta simply by buying less stocks. So no, it's simply a bet on volatility, not specifically on negative delta.
I also read somewhere that deep out of the money put options have proportionally higher prices, as they provide tail risk that "everybody and their mother" likes to have. If true, you must assume that this tail risk eventually materializes at some time; so again, you won't have positive expected returns if you include the tail risk.
It's also not a different asset class where you could argue you might have some anti-correlated returns. Tail risk events would be correlated with your equity portfolio which is usually the bulk of investors' risk allocation.
So, please convince me to start an options writing overlay. I have thought about it many times, but I'm not yet convinced. I hear that retail brokers make a ton of money in commissions and spreads from uneducated retail investors trading options though. Please show me an academic paper that suggest improved risk-adjusted returns for my portfolio. Coincidentally or not, I have not come across any institutional investor or hedge fund engaging in such a strategy; only retail investors.
Statistics: Posted by comeinvest — Sat Jun 01, 2024 2:01 am — Replies 8 — Views 838