Choosing the right options trading strategy: Risk-return trade-off and performance in different market conditions

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The investment decisions are subjected to risk and return of the financial asset. Options strategies help employ a suitable strategy to balance the risk-return trade-off. The study analyzes the risk-return trade-off of the long straddle, long strangle, long call butterfly (LCB), short straddle, short strangle, and short call butterfly (SCB) strategies. Moreover, it measures the impact of strategy risk and options premiums on strategy return using panel data analysis. Additionally, the study evaluates the performance of options strategies using the excess returns to risk approach under neutral and volatile market conditions. This paper considered companies of top-six sector indices of the National Stock Exchange from 2009 to 2020 and collected data of 18,720 option contracts and 3,744 observations for each strategy (22,464 observations). The study revealed that risks of long straddle and long strangle strategies have a positive impact, and options premiums negatively influence their payoff. ATM call premiums positively affect LCB payoff, while OTM and ITM call premiums positively influence SCB payoff. However, the risks of butterfly strategy did not influence its payoff. The risk of short straddle and short strangle strategies negatively influenced the payoff and were considered riskier strategies. Moreover, short straddle and short strangle strategies enhanced excess returns under both market conditions. The results would help the investors in choosing the appropriate strategy by analyzing the impact of risk on the payoff and the ability to enhance excess returns to the risk of various options strategies to incorporate in their investment.

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    • Table 1. Descriptive statistics of option strategies payoffs
    • Table 2. Augmented Dickey-Fuller test results
    • Table 3. Panel regression analysis for LCB and SCB strategies
    • Table 4. Panel regression analysis for long straddle and short straddle strategies
    • Table 5. Panel regression analysis for long strangle and short strangle strategies
    • Table 6. Excess returns to standard deviation in neutral market condition
    • Table 7. Excess returns to standard deviation in volatile market condition
    • Table 8. Excess returns to beta in neutral market condition
    • Table 9. Excess returns to beta in volatile market condition
    • Conceptualization
      Shivaprasad S. P., Geetha E., Raghavendra, Kishore L., Rajeev Matha
    • Data curation
      Shivaprasad S. P., Kishore L., Rajeev Matha
    • Formal Analysis
      Shivaprasad S. P., Geetha E., Raghavendra, Kishore L., Rajeev Matha
    • Investigation
      Shivaprasad S. P., Geetha E., Raghavendra, Kishore L., Rajeev Matha
    • Methodology
      Shivaprasad S. P., Raghavendra, Kishore L., Rajeev Matha
    • Resources
      Shivaprasad S. P., Geetha E., Rajeev Matha
    • Software
      Shivaprasad S. P., Geetha E.
    • Validation
      Shivaprasad S. P., Geetha E., Raghavendra, Kishore L.
    • Writing – original draft
      Shivaprasad S. P., Geetha E., Raghavendra, Kishore L., Rajeev Matha
    • Writing – review & editing
      Shivaprasad S. P., Geetha E., Raghavendra, Kishore L., Rajeev Matha
    • Funding acquisition
      Geetha E., Kishore L.
    • Project administration
      Geetha E., Raghavendra
    • Supervision
      Raghavendra, Kishore L.