Flight of the Condors: Evidence on the Performance of Condor Option Spreads in Australia
This paper examines whether superior nominal and risk-adjusted returns can be generated using condor option spread strategies on a large capitalized Australian stock. Monthly Commonwealth Bank of Australia Ltd (CBA) condor option spreads are constructed from 2012 to 2015 and their returns established. Standard and alternative measures are used to determine the nominal and risk-adjusted performance of the spreads. The results show that the short put condor spread produces superior nominal and risk-adjusted returns, but seemingly underperformed when the upside potential ratio was taken into consideration. The long iron condor spread also offers reasonable returns across both performance metrics. On the other hand, the short call condor, long call condor, short iron condor and long put condor spreads did not perform as well on a nominal and risk-adjusted return basis. The results suggest that constructing spreads on the foundation of volatility preferences could be a driver of performance for condor option spreads strategies. For instance, short volatility condor spreads with negatively skewed return distribution shapes appear to add value, while long volatility condor spreads with positively skewed return distribution shapes seem to be less attractive over the sample period. Overall, condor option spreads demonstrate high risk-return profiles, offer versatility in their construction and intended pay-off outcomes, create value in some instances and can be executed across varying market conditions. It is suggested that risk averse investors best avoid condor option spreads, while those with above average risk tolerances may be well suited to the strategies, particularly short volatility-driven condor spreads.
http://www.asx.com.au/documents/products/OptionsListingGuidelinesJan16.pdf, accessed 12 May 2017.
Australian Treasury. (2014) Financial System Inquiry: Final Report, December. Commonwealth of Australia, Canberra.
Benninga, S. and Blume, M. (1985) On the Optimality of Portfolio Insurance. Journal of Finance 40(5): 1341-1352.
Bernardo A.E. and Ledoit, O. (2000) Gain, Loss, and Asset Pricing. Journal of Political Economy 8(1): 144-172.
Black, F. (1975) Fact and Fantasy in the Use of Options. Financial Analysts Journal 31(4): 36-41 and 61-72.
Black, F. and Scholes, M. (1972) The Valuation of Option Contracts and a Test of Market Efficiency. Journal of Finance 27(2): 399–417.
Black, K. and Szado, E. (2015) Performance Analysis of Options-based Equity Mutual Funds, Closed-end Funds, and Exchange-traded Funds. Institute for Global Asset and Risk Management, Amherst, MA, 1-28.
Board, J., Sutcliffe, C. and Patrinos, E. (2000) The Performance of Covered Calls. The European Journal of Finance 6(1): 1-17.
Bookstaber, R. and Clarke, R.G. (1984) Option Portfolio Strategies: Measurement and Evaluation. Journal of Business 57(4): 469-492.
Booth, J.R., Tehranian, A. and Trennepohl, G.L. (1985) Efficiency Analysis and Option Portfolio Selection. Journal of Financial and Quantitative Analysis 20(4): 435-450.
Chaput, S. and Ederington, L. (2003) Option Spread and Combination Trading. Journal of Derivatives 10(4): 72-88.
—— (2005) Vertical Spread Design. Journal of Derivatives 12(3): 28-46.
—— (2008) Ratio Spreads. Journal of Derivatives 15(3): 41-57.
CME Group. (2015) The Remarkable Growth of Options on Futures,
http://openmarkets.cmegroup.com/9704/infographic-the-remarkable-growth-of-options-on-futures, accessed 15 January 2017.
El-Hassan, N., Hall, T. and Kobarg, J. (2004) Risk and Return of Covered Call Strategies for Balanced Funds: Australian Evidence,
http://www.asx.com.au/documents/products/covered_calls_report_final.pdf, accessed 15 January 2017.
Fahlenbrach, R. and Sandås, P. (2010) Does Information Drive Trading in Option Strategies? Journal of Banking and Finance 34(10): 2370-2385.
Fama. E. (1998) Market Efficiency, Long-Term Returns, and Behavioral Finance. Journal of Financial Economics 49(3): 283-306.
Figelman, I. (2008) Expected Return and Risk of Covered Call Strategies. Journal of Portfolio Management 34(4): 81-95.
Figlewski. S. and Green, T. (1999) Market Risk and Model Risk for a Financial Institution Writing Options. Journal of Finance 54(4): 1465-1499.
Financial Times. (2015) Global Fund Industry Manages Record $74tn,
http://www.ft.com/intl/cms/s/0/5a395bb4-24a6-11e5-9c4e-a775d2b173ca.html#axzz3xC1q6I6p, accessed 15 January 2017.
Frino, A. and Wearin, G. (2004) The Performance of Buy-Write Strategies: Investment Strategies. JASSA 4: 26-29.
Goodwin, T.H. (1998) The Information Ratio. Financial Analysts Journal 54(4): 34-43.
Groothaert, T. and Thomas, S. (2003) Creation of a Eurex Buy-Write Monthly Index on SMI,
http://bellmontsecurities.com.au/wp-content/uploads/2014/03/Creation-of-a-Eurex-Buy-Write-Monthly-Index-on-SMI.pdf, accessed 15 January 2017.
Hill, J., Balasubramanian, V. Gregory, K. and Tierens, I. (2006) Finding Alpha via Covered Call Writing. Financial Analysts Journal 62(5): 279-346.
Hoffman, A.O.I. and Fischer, E.T.S. (2012) Behavioral Aspects of Covered Call Writing: An Empirical Investigation. The Journal of Behavioral Finance 13(1): 66-79.
Hübner, G. (2016) Option Replication and the Performance of a Market Timer. Studies in Economics and Finance 33(1): 2-25.
Jarnecic, E. (2004) The Buy-Write Strategy versus the Index Portfolio. JASSA, 2: 36-39.
Jensen, M.C. (1968) The Performance of Mutual Funds in the Period 1945-1964. The Journal of Finance 23(2): 389-416.
Kapadia, N. and Szado, E. (2007) The Risk and Return Characteristics of the Buy Write Strategy on the Russell 2000 Index Journal of Alternative Investments 9(4): 39-56.
Leggio, K.B. and Lien, D. (2002) Covered Call Investing in a Loss Aversion Framework. The Journal of Psychology and Financial Markets 3(3): 182-191.
Lhabitant, F.S. (1999) On the Performance of Option Strategies in Switzerland. Finanzmarkt und Portfolio Management 13(3): 318-338.
—— (2000) Derivatives in Portfolio Management: Why Beating the Market is Easy, Derivatives Quarterly 7(2): 39-45.
Mahdavi, M. (2004) Risk-Adjusted Return When Returns Are Not Normally Distributed: Adjusted Sharpe Ratio. Journal of Alternative Investments 6(4): 47-57.
McIntyre, M.L., and Jackson, D. (2007) Great in Practice, Not in Theory: An Empirical Examination of Covered Call Writing. Journal of Derivatives and Hedge Funds 13(1): 66-79.
McKeon, R. (2016) Option Spread Trades: Returns on Directional and Volatility Trades, Journal of Asset Management 16(6): 422-433.
Merton, R. C., Scholes, M.S. and Gladstein, M.L. (1978) The Returns and Risk of Alternative Call Option Portfolio Investment Strategies. Journal of Business 51(2): 183-242.
Modigliani, F. and Modigliani, L. (1997) Risk-adjusted Performance. The Journal of Portfolio Management 23(2): 45-54.
Mugwagwa, T., Ramiah, V. Naughton, T. and Moosa, I. (2012) The Efficiency of the Buy-Write Strategy: Evidence from Australia. International Financial Markets, Institutions and Money 22(2): 305-328.
Niblock, S.J. and Sinnewe, E. (forthcoming) Are Covered Calls the Right Option for Australian Investors? Studies in Economics and Finance, in press.
O'Connell, D. and O'Grady, B. (2014) The Buy-Write Strategy, Index Investment, and the Efficient Market Hypothesis: More Australian Evidence. Journal of Derivatives 22(1): 71-89.
Reilly, F. K. and Brown, K.C. (1997) Investment Analysis and Portfolio Management, 5th ed. Fort Worth, TX: The Dryden Press.
Rendleman, R. (2001) Writing from an Expected Utility Perspective. Journal of Derivatives 8(3): 63-75.
Sharpe, W.F. (1966) Mutual Fund Performance. Journal of Business 39(1): 119-138.
Simon, D.P. (2011) The Anomalous Behavior of the S&P Covered Call Closed End Fund. Journal of Derivatives and Hedge Funds 17(2): 165-180.
—— (2013) Active QQQ Covered Call Strategies. Journal of Alternative Investments 16(3): 25-36.
Sortino, F.A. and van der Meer, R. (1991) Downside Risk. The Journal of Portfolio Management 17(4): 27-31.
Sortino, F.A., van der Meer, R. Plantinga, A. and Forsey, H. (2003) The Upside Potential Ratio: What are we Trying to Measure?
http://www.edge-fund.com/SMPF03.pdf, accessed 20 January 2017.
Standard and Poors. (2017) S&P/ASX 200 index,
https://au.spindices.com/indices/equity/sp-asx-200, accessed 12 May 2017.
Whaley, R. (2002) Return and Risk of CBOE Buy Write Monthly Index. Journal of Derivatives 10(2): 35-42.
Copyright (c) 2017 Applied Finance Letters
This work is licensed under a Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License.
Authors submitting articles for publication warrant that the work is not an infringement of any existing copyright and will indemnify the publisher against any breach of such warranty. By publishing in Applied Finance Letters, the author(s) retain copyright but agree to the dissemination of their work through Applied Finance Letters.
By publishing in Applied Finance Letters, the authors grant the Journal a Creative Commons nonexclusive worldwide license (CC-BY-NC-ND: Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License) for electronic dissemination of the article via the Internet, and, a nonexclusive right to license others to reproduce, republish, transmit, and distribute the content of the journal. The authors grant the Journal the right to transfer content (without changing it), to any medium or format necessary for the purpose of preservation.
Authors agree that the Journal will not be liable for any damages, costs, or losses whatsoever arising in any circumstances from its services, including damages arising from the breakdown of technology and difficulties with access.