Hostname: page-component-7b7567c8c-tnzcf Total loading time: 0 Render date: 2026-11-14T21:23:07.897Z Has data issue: false hasContentIssue false
  • English
  • Français

Efficiency Analysis and Option Portfolio Selection

Published online by Cambridge University Press:  06 April 2009

James R. Booth,
Hassan Tehranian and
Gary L. Trennepohl
Get accessRights & Permissions [Opens in a new window]

Abstract

The unique characteristics of options enable investors to create nonnormal portfolio return distributions that cannot be replicated with other assets. This analysis explores the power of various investment selection criteria to identify efficient portfolios from investment strategies involving call options and treasury bills, stocks, and covered option writing. The preference structure for strategies incorporating options is compared to traditional stock-fixed income investments, and the importance of options to investor utility maximization is illustrated. This study reveals that rules of stochastic dominance that place few restrictions on investor preference functions and asset return distribution are appropriate criteria by which to rank portfolios containing options and other assets.

Information

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 20 , Issue 4 , December 1985, pp. 435 - 450
Copyright
Copyright © School of Business Administration, University of Washington 1985

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Article purchase

Temporarily unavailable

References

[1]Banz, R., and Miller, M.. “Prices for State-Contingent Claims: Some Estimates and Applications.” Journal of Business, Vol. 51 (10 1978), pp. 653–672.CrossRefGoogle Scholar
[2]Bawa, V. J. “Optimal Rules for Ordering Uncertain Prospects.” Journal of Financial Economics, Vol. 2 (03 1975), pp. 95–112.CrossRefGoogle Scholar
[3]Black, Fischer, and Scholes, M.. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, Vol. 81 (05/06 1973), pp. 637–654.CrossRefGoogle Scholar
[4]Bookstaber, Richard M.Option Pricing and Strategies in Investing. Reading, MA: Addison-Wesley (1981).Google Scholar
[5]Bookstaber, Richard M., and Clarke, Roger. “An Algorithm to Calculate the Return Distribution of Portfolios with Option Positions.” Management Science, Vol. 29 (04 1983), pp. 419–429.CrossRefGoogle Scholar
[6]Breeden, D., and Litzenberger, R.. “Prices of State-Contingent Claims Implicit in Option Prices.” Journal of Business, Vol. 51 (10 1978), pp. 621–651.CrossRefGoogle Scholar
[7]Breen, K. W., and Savage, J.. “Portfolio Distributions and Tests of Security Selection Models.” Journal of Finance, Vol. 23 (12 1968), pp. 805–819.Google Scholar
[8]Chiras, D. P., and Manaster, S.. “The Information Content of Option Prices and a Test of Market Efficiency.” Journal of Financial Economics, Vol. 6 (06/09 1978), pp. 213–334.CrossRefGoogle Scholar
[9]Conine, T., and Tamarkin, M.. “On Naive Diversification Given Asymmetry in Returns.” Journal of Finance, Vol. 36 (12 1981), pp. 1143–1155.CrossRefGoogle Scholar
[10]Fama, E. F. “The Behavior of Stock Market Prices.” Journal of Business, Vol. 38 (01 1965), pp. 34–105.CrossRefGoogle Scholar
[11]Fishburn, P. C. “Convex Stochastic Dominance with Continuous Distribution Functions.” Journal of Economic Theory, Vol. 7 (02 1974), pp. 143–158.CrossRefGoogle Scholar
[12]Fredman, A., and Moore, R. J.. “Cutting Losses and Gaines.” Barrons, Vol. 62 (10 18, 1982), pp. 44+.Google Scholar
[13]Galai, D. “Tests of Market Efficiency of the Chicago Board Options Exchange.” Journal of Business, Vol. 50 (04 1977), pp. 167–197.CrossRefGoogle Scholar
[14]Hadar, J., and Russell, W.. “Rules for Ordering Uncertain Prospects.” American Economic Review, Vol. 59 (03 1969), pp. 25–34.Google Scholar
[15]Hakansson, N. “Welfare Aspects of Options and Supershapes.” Journal of Finance, Vol. 33 (06 1978), pp. 759–776.CrossRefGoogle Scholar
[16]Hanoch, G., and Levy, H.. “The Efficiency Analysis of Choices Involving Risk.” Review of Economic Studies, Vol. 36 (07 1969), pp. 335–346.CrossRefGoogle Scholar
[17]Jean, W. H. “Comparison of Moment and Stochastic Dominance Ranking Method.” Journal of Financial and Quantitative Analysis, Vol. 10 (03 1975), pp. 151–160.CrossRefGoogle Scholar
[18]Jean, W. H. “The Geometric Mean and Stochastic Dominance.” The Journal of Finance, Vol. 35 (03 1980), pp. 151–158.CrossRefGoogle Scholar
[19]Klemkosky, Robert, and Resnick, B.. “Put-Call Parity and Market Efficiency.” Journal of Finance, Vol. 34 (12 1979), pp. 1141–1155.Google Scholar
[20]Kroll, Yoram, and Levy, Haim. “Stochastic Dominance: A Note.” Journal of Finance, Vol. 37 (06 1982), pp. 871–875.CrossRefGoogle Scholar
[21]Leland, H. “Who Should Buy Portfolio Insurance?” Journal of Finance, Vol. 35 (05 1980), pp. 581–596.CrossRefGoogle Scholar
[22]Levy, Haim, and Kroll, Yoram. “Ordering Uncertain Options with Borrowing and Lending.” Journal of Finance, Vol. 33 (05 1978), pp. 553–574.CrossRefGoogle Scholar
[23]Levy, Haim, and Kroll, Yoram. “Efficiency Analysis with Borrowing and Lending.” The Review of Economics and Statistics, Vol. 61 (02 1979), pp. 125–130.CrossRefGoogle Scholar
[24]Levy, Haim, and Hanoch, Giora. “Relative Effectiveness of Efficiency Criteria for Portfolio Selection.” Journal of Financial and Quantitative Analysis, Vol. 5 (03 1970), pp. 63–76.CrossRefGoogle Scholar
[25]Markowitz, Harry. “Portfolio Selection”. Cowles Foundation Monograph 16. New York: John Wiley and Sons, Inc. (1959).Google Scholar
[26]Markowitz, Harry. “Portfolio Selection.” Journal of Finance, Vol. 7 (03 1952), pp. 77–91.Google Scholar
[27]Merton, Robert C. “Theory of Rational Option Pricing.” Bell Journal of Economics and Management Science, Vol. 4 (Spring 1973), pp. 141–183.Google Scholar
[28]Merton, Robert C.; Scholes, M.; and Gladstein, M.. “The Returns and Risk of Alternative Call Option Portfolio Investment Strategies.” Journal of Business, Vol. 51 (04 1978), pp. 182–242.Google Scholar
[29]Merton, Robert C.; Scholes, M.; and Gladstein, M.. “The Returns and Risks of Alternative Put-Option Portfolio Investment Strategies.” Journal of Business, Vol. 55 (04 1982), pp. 1–55.CrossRefGoogle Scholar
[30]Phillips, Susan M., and Smith, C. W.. “Trading Costs for Listed Options.” Journal of Financial Economics, Vol. 8 (06 1980), pp. 179–201.CrossRefGoogle Scholar
[31]Porter, R. B. “Semi-variance and Stochastic Dominance: A Comparison.” American Economic Review, Vol. 64 (03 1974), pp. 200–204.Google Scholar
[32]Porter, R. B., and Gaumnitz, J.. “Stochastic Dominance vs. Mean Variance Portfolio Analysis.” American Economic Review, Vol. 62 (06 1972), pp. 438–446.Google Scholar
[33]Porter, R. B., and Bey, Roger. “An Evaluation of the Empirical Significance of Optimal Seeking Algorithms.” Journal of Finance, Vol. 29 (12 1974), pp. 1479–1490.Google Scholar
[34]Quirk, J. P., and Saposnik, R.. “Admissibility and Measurable Utility Functions.” Review of Economic Studies, Vol. 29 (02 1962), pp. 140–146.CrossRefGoogle Scholar
[35]Rendleman, Richard J. Jr, “Optimal Long Run Option Investment Strategies.” Financial Management, Vol. 10 (Spring 1981), pp. 61–76.CrossRefGoogle Scholar
[36]Ross, S. “Options and Efficiency.” Quarterly Journal of Economics, Vol. 90, (02 1976), pp. 75–89.CrossRefGoogle Scholar
[37]Rothschild, M., and Stiglitz, J. E.. “Increasing Risk: A Definition.” Journal of Economic Theory, Vol. 2 (09 1970), pp. 225–243.CrossRefGoogle Scholar
[38]Sears, R. Stephen, and Trennepohl, Gary. “Diversification and Skewness in Option Portfolios.” Journal of Financial Research, Vol. 6 (Fall 1983), pp. 199–212.CrossRefGoogle Scholar
[39]Sears, R. Stephen, and Trennepohl, Gary. “Measuring Portfolio Risk in Options.” Journal of Financial and Quantitative Analysis, Vol. 17 (09 1982), pp. 392–409.CrossRefGoogle Scholar
[40]Tehranian, H. “Empirical Studies in Portfolio Performance Using Higher Degrees of Stochastic Dominance.” Journal of Finance, Vol. 35 (03 1980), pp. 159–171.CrossRefGoogle Scholar
[41]Trippi, R. “A Test of Option Market Efficiency Using a Random Walk Valuation Model.” Journal of Economics and Business, Vol. 29 (Winter 1977), pp. 93–98.Google Scholar
[42]Whitmore, G. A. “Third Degree Stochastic Dominance.” American Economic Review, Vol. 60 (06 1970), pp. 457–459.Google Scholar