The cash-secured put-write strategy and the variance risk premium

Abstract

A cash-secured put-write (PUTW) strategy involves writing an at-the-money put option and setting aside enough cash to buy the underlying. Empirically, the PUTW returns outperform the returns predicted by the traditional one- three- and five-factor models. We explain the outperformance. A model where the market is subject to disasters generates a Variance Risk Premium (VRP), which reflects information about both the risk aversion and the impact of disasters. VRP, when added to the market factor, accounts for the PUTW outperformance. This factor also explains abnormal returns for other derivative strategies.