Impact of options trading strategies on profitability empirical evidence from the Indian stock market

Abstract

Driven by the increasing trading volumes in index options, the present study examines a measure of profitability, namely, hold to maturity returns for directional and non-directional options trading strategies for the Indian stock market. Directional strategies refer to call and put options with varying strike prices, whereas non-directional strategies refer to the straddle and strangle. The characteristics of realized returns are analyzed by employing descriptive statistics, histograms, and boxplots whereas median differences are tested by the Wilcoxon Signed Rank test. Further, the study determines the degree of correlation between index option return determinants and strategy returns. In order to determine the impact of index option return determinants on the selected strategy returns, a time series methodology, that is the Autoregressive Distributed Lag (ARDL) framework has been employed. The results indicate that the change in the underlying Nifty is a significant predictor of profitability for directional strategies, while the change in the volatility index is a significant predictor for both directional and non-directional strategy returns. The results for the volatility mispricing indicator reveal that a negative volatility risk premium is priced in returns for put options and non-directional strategy returns. Additionally, the short-run predictors are similar to those in the long run indicating that their significance holds in the short run as well and the error correction term indicates the restoration of the long-run relationships in an average of 10-12 months. The results and implications for practice are valuable for academics as well as retail investors and traders in the Indian market. newline