Evaluation of Investment Strategies with Options

The financial literature has revealed that option strategies originate asymmetric return distributions, providing new investment opportunities, particularly in the control and reduction of risk. On the other hand, given the inadequacy of the measures based upon mean and variance, we highlight the work of Leland (1999), which proposes a modification of the traditional risk measure (beta) of the Capital Asset Pricing Model (CAPM) to incorporate other moments of the return distributions. In this context, we applied this methodology on six dynamic hedging strategies with options on the FTSE 100 Index (covered calls at-, in- and out-of-the-money and protective puts at-, in- and out-of-the-money), in the sense of evaluating its performance. The results indicate that the new risk measure is statistically more significant than the traditional beta of CAPM, for that the information supplied by the measure of the performance (modified alpha) seems to be more reliable. However, the values of modified alphas reveal that these dynamic strategies result in excess returns close to zero (as theoretically expected), suggesting that the market price of these options appears to be in equilibrium, i.e., the options seem to be correctly priced.