Journal of Risk

Evaluating the risk of portfolios with options

Elizabeth A. Sheedy and Robert G. Trevor


Many portfolio managers use options in their investment strategy, exacerbating the potential for asymmetric, time-varying, and discontinuous portfolio distributions. While the existence of such problems is commonly acknowledged, the issue of risk measurement for option-affected portfolios remains unresolved. This study examines the nature of risk for option-affected portfolios and considers whether simple measures of changing risk can adequately capture their complex dynamics. It is found that the main issue is not skewness (as is commonly supposed), but the fact that risk is changing. The implication is that option-affected (and other) portfolios can be meaningfully examined in a mean-variance framework using risk measures readily available to practitioners.

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