Systematically Harvesting the Volatility Premium
Investors can use option-writing funds to take advantage of the volatility risk premium and to diversify their equity portfolio risk.
Investors usually consider option-writing strategies as a means of generating income, or as an avenue for achieving equity-like returns with less risk. Neither categorization is necessarily wrong, but they overlook option-writing strategies’ potential diversification benefits.
Equity index option-writing strategies can help diversify equity portfolios by adding exposure to the volatility premium. The volatility premium is the difference between an asset’s implied (expected) volatility and its realized (actual) volatility over a given period. Recent research has shown that the average volatility premium measured positive 3.4% per year and was positive for 88% of the months from January 1986 to December 2014 .
Adam McCullough does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.