TY - JOUR T1 - An Error of Collateral: <em>Why Selling</em> <br/> <em>SPX Put Options May Not be Profitable</em> JF - The Journal of Derivatives SP - 31 LP - 42 DO - 10.3905/jod.2013.20.3.031 VL - 20 IS - 3 AU - Efraim Berkovich AU - Yochanan Shachmurove Y1 - 2013/02/28 UR - https://pm-research.com/content/20/3/31.abstract N2 - One of the favorite exercises in financial research is to set up an investment strategy based on some criterion of interest and use historical data to test whether it would have earned excess returns. Honest testing, of course, requires trying the strategy with out-of-sample data that was not used in fitting model parameters.Typically, returns are computed relative to the cost to set up the position. For a trade like a short sale that produces a cash inflow at the outset—essentially a loan from the market—excess return is measured by the reduction in the cost of funds below the riskless borrowing rate. A strong, and rather puzzling, result found by many researchers over the years is that equity put options seem to be overpriced on average. The excess returns from writing puts appear to be higher than should be required to satisfy nearly any plausible kind of investor utility function. What this analysis does not take into account, however, is that for many such trades collateral has to be posted, and adjusted daily as the position is marked to market. In this article, Berkovich and Shachmurove consider several trading strategies involving options on the S&amp;P index and the VIX, taking account of the amount and cost of the margin deposits required to carry the positions. They find that while the margin is pathdependent and can’t be known a priori when the trade is initiated, the effect on profitability is large, to the point that apparently high alphas from put writing can easily become negative once the actual cost of implementing the trade is fully taken into account.TOPICS: Statistical methods, options ER -