The Supreme Myth of the Risk of Options Debunked, Part 2

Published on: May 23 2014 by John Critchley

By:  John J. Critchley, Jr.

For those of us in the Options universe, there are few items more discouraging than constantly having to dispel the widely held, yet untrue myth of “Options are Risky”.  There is nothing further from the truth.

If you disagree with me,  please allow me to make my case.  Would you believe an University of Massachusetts professor of Finance, Edward Szado and his colleague, Thomas Schneeweis, Professor of Finance, Isenberg School of Management, University of Massachusetts who embarked on a multi-year study  that provided extensive analysis of the performance of option collar strategies over a diverse set of asset classes including equities, currencies, commodities, fixed income, and real estate?

Their findings?    In their recent research, Option-Based Risk Management in a Multi-Asset World.covering the period from June 1, 2007 to December 30, 2011, capturing both the financial crisis as well as the following market recovery, here are the two key findings:

Here is a summary of two key points:

 

1)            The results of the analysis show that for most of the asset classes considered, an option based

collar strategy, using six-month put purchases and consecutive one-month call writes, provides improved risk-adjusted performance and significant risk reduction.

 

2)            More importantly, while option-based collars may not provide complete protection for all products and in all market conditions, collars can provide significant risk control across a wide range of asset classes, significantly reducing volatility, drawdowns, and, in certain market environments, can also provide enhanced returns relative to a stand-alone investment.

 

Here is a simplified analysis of the findings provided by the OCC:

“An example of the benefit of an equity collar strategy can be seen with the analysis on the popular SPDR S&P 500 (SPY) ETF. Over the study period, the 2% out-of-money SPY collar returned over 22% while the long SPY experienced a loss of over 9%. The ( option) collar earned its superior returns with less than half the risk as measured by the standard deviation (8.4% for the collar versus 19.5% for SPY).”

 

This is the important point:  superior returns with less than half the risk

This is quite a compelling case that backs up the idea that most equity traders should probably trade options in some manner.  If one properly educates oneself about options, boosting one’s portfolio and reducing risk is readily attainable.

For anyone apprehension about options and inclined to believe they are risky trades to be avoided at all costs, I highly recommend that you read their findings:

http://www.optionseducation.org/content/dam/oic/documents/literature/files/options-based-risk-mgmt.pdf

 

 Stay tuned………

 

 

Disclaimer


We are not liable for any trading decisions made by any reader. NO advice is given or implied. The information offered in  this article is for demonstration purposes ONLY and should not to be either construed as an offer or considered to be a recommendation to buy or sell any options .

Your use of this information is entirely at your own risk. It is your sole responsibility to evaluate the accuracy, completeness and usefulness of the information. You must assess the risk of any trade with a professional broker, or financial planner, and make your own independent decisions regarding any trades mentioned herein. This is not a solicitation to buy or sell any options, or to purchase or sell any credit spreads. Trading options only carries a high degree of risk, is not suitable for all traders/investors, and you may lose all of your premium money invested in the options. If you have never traded options before, we strongly recommend that you read a little background information made available by the government. Only you can determine what level of risk is appropriate for you. Also, prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options.

Past performances DO NOT guarantee future results. Please consult with your own independent tax, business and financial advisors with respect to any trade. We will NOT be responsible for the consequences of anyone acting on this purely demonstration material.

 

 

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