Out of the Money or Striking It Rich? Evidence on the Risk-Adjusted Return Performance of Options-Based Equity Funds versus the S&P 500 and Other Benchmark Alternatives

Abstract

This article examines the risk–return characteristics of 29 options-based equity funds, their self-specified S&P 500 total return benchmark index, and a suite of alternative options-based strategy indexes in the United States from 2010 to 2015. Using a multifactor risk-adjustment model, the authors attempt to establish whether fund managers are choosing suitable benchmark indexes in terms of their funds’ investment style/strategy and risk profile. Our findings indicate that options-based fund managers are unable to outperform both before and after adjusting for risk and after consideration of management/transaction costs. They also show that the S&P 500 total return index may not be the most appropriate benchmark for options-based funds. For instance, options-based fund managers appear to be selecting broad-based equity benchmark indexes that do not adequately reflect the risk–return characteristics associated with the funds’ investment strategy/options trading activities, thus understating their risk-adjusted performance. By considering alternative approaches to abnormal performance measurement, fund managers, investors, market regulators, and academics can significantly change the conclusions they draw regarding the economic contribution of options-based fund managers. Furthermore, market participants can more accurately assess risk-adjusted options-based performance and fund-specific risk characteristics relative to the benchmark index chosen by the manager or to alternative benchmark indexes.