Option Portfolio Strategies: Measurement and Evaluation

Abstract

It is well known that options can increase the flexibility of returns available from investment strategies. Papers by Ross (1976), Breeden and Litzenberger (1978), and Arditti and John (1980) point toward spanning opportunities which increase the efficiency of the financial markets in meeting the investment objectives of investors. While these and other studies have demonstrated the potential of option portfolio strategies in molding the return distribution to better fit risk preferences, a number of other studies have used simulation techniques to give an empirical view of just what effect particular option stock and option bond strategies will have in altering risk return patterns. A major study in this area is that of Merton, Scholes, and Gladstein (1978, 1982). Their study, presented in two papers, one on call option portfolio strategies (hereinafter MSGl) and the other on put option portfolio strategies (hereinafter MSG2), presents a broad and insightful discussion of many of the implications of combining options with stock portfolios. The MSG study employs a 12.5-year period for simulations in the first paper on portfolios using call options and a 14-year simulation period in the second paper on portfolios using put options. As they are careful to point out, their results depend on market trends which may not match ex ante expecta-