Version 1
: Received: 1 November 2024 / Approved: 4 November 2024 / Online: 5 November 2024 (08:30:53 CET)
How to cite:
USTUNDAG, A.; SIVRI, M. S.; ARI, E. Higher Returns, Lower Risks: Empirical Evidence from US Options Markets. Preprints2024, 2024110257. https://doi.org/10.20944/preprints202411.0257.v1
USTUNDAG, A.; SIVRI, M. S.; ARI, E. Higher Returns, Lower Risks: Empirical Evidence from US Options Markets. Preprints 2024, 2024110257. https://doi.org/10.20944/preprints202411.0257.v1
USTUNDAG, A.; SIVRI, M. S.; ARI, E. Higher Returns, Lower Risks: Empirical Evidence from US Options Markets. Preprints2024, 2024110257. https://doi.org/10.20944/preprints202411.0257.v1
APA Style
USTUNDAG, A., SIVRI, M. S., & ARI, E. (2024). Higher Returns, Lower Risks: Empirical Evidence from US Options Markets. Preprints. https://doi.org/10.20944/preprints202411.0257.v1
Chicago/Turabian Style
USTUNDAG, A., MAHMUT SAMI SIVRI and EMRE ARI. 2024 "Higher Returns, Lower Risks: Empirical Evidence from US Options Markets" Preprints. https://doi.org/10.20944/preprints202411.0257.v1
Abstract
The core principle of investment posits a direct correlation between risk and return. In the language of finance, "risk" refers to the degree of uncertainty or the likelihood of financial loss associated with an investment choice. Conventional wisdom holds that as investment risk escalates, investors expect higher returns as compensation for the increased risk they undertake. Yet, the interplay between risk and return is not always linear or predictable. This study utilized optimization modeling in the options market to investigate the risk-return relationship, focusing on how returns change with different risk levels. Concentrating on the short iron condor strategy, with its capped risk and return, the research aimed to maximize returns within various loss scenarios. This method clarified return levels at different risk thresholds and emphasized the short iron condor strategy's role in delineating the risk-return dynamics. Using 2023 data, research on the 14 most traded US equity and 9 ETF options, with maturities ranging from 5 to 20 days, identified a clear relationship between risk, measured by both maximum loss levels and price fluctuations, and potential returns in short iron condor strategies. While higher maximum loss limits led to larger potential returns, the risk-adjusted returns, expressed as the return-to-risk ratio, declined as risk increased. However, with increased price fluctuations, the potential return actually decreased due to the capped profit potential of the strategy, showing a different dynamic compared to maximum loss risk. Furthermore, longer time to maturity further reduced this ratio, highlighting that both the level of risk and the duration of the position play critical roles in determining returns. These findings emphasize the complex balance between risk and return, and the diminishing marginal benefits of increasing risk and holding periods in short iron condor strategies.
Keywords
Risk-return relationship; optimization modeling; options market; short iron condor strategy
Subject
Business, Economics and Management, Finance
Copyright:
This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
