but wouldn’t the in the money have deltas near 1 and fluctuate a lot more than the out of the money. The market values would change a lot, boosting the std deviation. The OTM calls wouldn’t change by as much. I assumed that the std dev would factor in fluctuations in the market value of the option.
C’mon. Suppose that I run a hedge fund and I sell a GM December call with strike = 5 and collect (I dunno) $15, what does that do to my P/L that day? Ans: Nothing. If I record a $15 gain on that, collect June incentive fees on my $15 gain, then I will be lucky if I avoid going to jail.
*Selling calls provides income… ie returns. If they are out of money, they don’t need to record any unrealized capital losses. *Long time periods skew sharpe higher. *Illiquidity masks the true volatility, thus leading to a higher Sharpe.
With in-the-money calls, the value will rise and fall more with market prices - so the volatility will reflect at least some of the risk (higher delta, to get technical). With out of the money calls, you get profit, and very little change in value (delta near zero, unless the price jumps); so you’re getting profit without volatility, but taking on HUGE downside risk that won’t necessarily be reflected in the variance.
So, what’s the final work on this? Use of in-the-money or out-of-money calls?
Jed is right. Quite easy question… OTM produce a huge negative skew
correct - it has to be OTM option selling only
An even better gig is buying illiquid securities and marking them to model…
I now agree with the OTM trades increases Sharpe. And that certainly appears to be the correct answer to the question.