More than 40 years ago, Merton et al. published two papers [1,2] examining the performance of passive options strategies. They concluded that these strategies outperformed the traditional buy-and-hold approach. At the time of their studies, options data was not widely available, so they used historical volatility to calculate options prices. Merton et al. conducted their research by simulating the impact of options on two portfolios: a broad market proxy of 136 equities and the Dow Jones 30 index. Using a twelve-year period, the backtest incorporated historical volatility and applied the Black–Scholes-Merton model to price the options.
Since then, the options market has become highly liquid, with significant structural changes. A recent article [3] reexamines the strategies studied by Merton et al., along with additional strategies, using actual options data from the period 2012 to 2023. The strategies studied include Call-Write strategies (with seven variants), Put-Write strategies (with two variants), and the Protective Put (PPUT) strategy.
The authors pointed out,
The recent review shows that the original option strategies recommended by Merton et al. no longer provide a favorable return-to-risk ratio. It is likely that these returns were illusory, driven by their assumptions. After all, they were based on a simulation.
Recent data demonstrate that simple options strategies no longer add value to a portfolio or an index. However, our research shows that three well-known and somewhat dynamic option strategies have outperformed the S&P 500 Index on a return-to-risk basis. Furthermore, we find that the favorable performance observed in previous studies can be revitalized by incorporating simple signals of the market regime in their construction.
An interesting finding of this study is that PPUT consistently outperforms the S&P 500 Index on a return-to-risk basis. Even more astonishing is that by adding the simple logic of avoiding puts after a one-standard-deviation draw down, it outperforms the index on a return basis with significantly lower risk. A key reason for the PPUT index and the logic-based PPUT strategy outperformance may be that as more firms implement covered call strategies, they inadvertently reduce implied volatility levels, underpricing the risk in the tails of the distribution. This hypothesis needs to be tested with a larger set of indices.
In short, none of the simple options strategies have outperformed the S&P 500. Interestingly, the PPUT strategy outperforms the buy-and-hold approach on a risk-adjusted basis, and the VIX is shown to be an effective regime filter.
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References
[1] Merton, Robert C., Myron S. Scholes, and Mathew L. Gladstein. 1978. The Returns and Risk of Alternative Call Option Portfolio Investment Strategies. Journal of Business 51: 183–242.
[2] Merton, Robert C., Myron S. Scholes, and Mathew L. Gladstein. 1982. The Returns and Risks of Alternative Put-Option Portfolio Investment Strategies. Journal of Business 55: 1–55.
[3] Andrew Kumiega, Greg Sterijevski, and Eric Wills, Black–Scholes 50 Years Later: Has the Outperformance of Passive Option Strategies Finally Faded?, International Journal of Financial Studies 12: 114.
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