Construction and Hedging of Equity Index Options Portfolios

TL;DR

This paper evaluates systematic index option-writing strategies on the S&P500, comparing hedging models and sizing methods, and finds that intraday rehedging can improve risk-adjusted returns over buy-and-hold strategies.

Contribution

It provides a comprehensive comparison of BSM and VG models for hedging, with detailed analysis of rehedging frequency and sizing methods in index options portfolios.

Findings

BSM model generally outperforms VG in hedging accuracy

Intraday rehedging at 130-minute intervals balances risk and return

Systematic option-writing strategies can outperform buy-and-hold benchmarks

Abstract

This research presents a comprehensive evaluation of systematic index option-writing strategies, focusing on S&P500 index options. We compare the performance of hedging strategies using the Black-Scholes-Merton (BSM) model and the Variance-Gamma (VG) model, emphasizing varying moneyness levels and different sizing methods based on delta and the VIX Index. The study employs 1-minute data of S&P500 index options and index quotes spanning from 2018 to 2023. The analysis benchmarks hedged strategies against buy-and-hold and naked option-writing strategies, with a focus on risk-adjusted performance metrics including transaction costs. Portfolio delta approximations are derived using implied volatility for the BSM model and market-calibrated parameters for the VG model. Key findings reveal that systematic option-writing strategies can potentially yield superior returns compared to buy-and-hold benchmarks. The BSM model generally provided better hedging outcomes than the VG model, although the VG model showed profitability in certain naked strategies as a tool for position sizing. In terms of rehedging frequency, we found that intraday hedging in 130-minute intervals provided both reliable protection against adverse market movements and a satisfactory returns profile.