Puts and Calls

Puts and calls are inputs when you've enabled the options strategy.  Options strategy can be activated through the Options Menu in the Optimizer ribbon.  Upon activation, six new columns appear on the Inputs Worksheet between the Annualized Market Forecasts and the Correlations.  Three of these columns are for puts, the other three for calls. To assign a put or call to an asset, the user must input the strike price, cost, and coverage. New Frontier puts and calls apply generally to the resampling procedure in both optimizations and rebalance tests.  They remain in place and always affect the return distribution in all resampled returns.  In the resampling process, during optimization or calculation of the rebalancing test, resampled returns beyond the strike price are converted to the strike price if the coverage is set at 100%.  For less than 100% coverage, the designated percentage coverage is moved to the strike price, producing a return that is as weighted combination of the strike price and the resampled return.  The strike is given as a percentage relative to the current price, rather than an absolute price as is the case in most real-world puts and calls.  They are also assumed to be repeated for each time period.  This is in contrast to real-world options, which expire on a particular date and are only used once.

The three fields are similar for puts and calls; more detailed descriptions follow:

Strike:

The strike is specified as an annualized return.  Note that this may require a conversion if the units of return are monthly or quarterly.  If a one-period annualized return is less than the strike, any existing put option is exercised. Similarly, if the one-period annualized return is greater than the specified strike, any existing call option is exercised. There is no general restriction on strike prices.  Out-of-the-money puts and calls can be entered into the Optimizer.  It is up to the user to make sure that these investments are sensible, since they can dramatically alter the resulting allocations and be dangerous if used recklessly.

Cost:

The cost is again specified as an annualized percentage.  Note that this too may require a conversion.  Mispriced options may force an asset to be overused or underused in an asset allocation; correct pricing is important when entering options into the optimizer.  It is the user’s responsibility to ascertain and enter correct pricing for any options entered.

Coverage:

Coverage is expressed as a percentage of holdings of the underlying asset and is unrestricted.  Positive coverage implies buying, and negative coverage implies selling the option. Note that ordinary coverage for call sales is measured in negative percentages. The designated percentage of the holdings covered by an option, if exercised, will be bought/sold at the strike price.