3433-vol. 6 issue 2-3.pmd - iarfc

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118 Journal of Personal Finance Table 2 Bull Call Spread vs. Stock Investment: Monthly Return January 1990 – December 2003 Bull Call Spread a Stock Investment Dow Jones Average Standard Sharpe Average Standard Sharpe Companies Return Deviation Ratio b Return Deviation Ratio Alcoa -23.96% 22.08% -1.10 1.23% 8.61% 0.10 AIG -22.36% 29.54% -0.77 1.46% 7.53% 0.15 Altria Group -17.04% 29.57% -0.59 1.06% 8.72% 0.08 AT&T -15.03% 50.67% -0.30 0.41% 11.47% 0.00 Boeing -15.90% 31.91% -0.51 0.96% 9.76% 0.06 Citigroup -18.97% 39.46% -0.49 2.27% 9.51% 0.20 Caterpillar -19.90% 24.57% -0.82 0.83% 10.16% 0.05 Coca-Cola -13.91% 28.59% -0.50 1.28% 7.19% 0.13 DuPont -14.59% 31.10% -0.48 0.71% 7.20% 0.05 Disney -19.86% 27.48% -0.74 0.98% 8.71% 0.07 Eastman Kodak -13.11% 51.39% -0.26 0.14% 8.67% -0.03 Exxon Mobil -13.13% 32.84% -0.41 0.85% 5.10% 0.10 General Electric -15.69% 26.93% -0.60 1.39% 7.50% 0.14 General Motors -10.37% 33.90% -0.32 0.64% 9.60% 0.03 Hewlett-Packard -17.97% 25.23% -0.73 1.81% 10.54% 0.14 Home Depot -19.50% 29.14% -0.68 2.19% 9.38% 0.20 Honeywell -22.16% 35.05% -0.64 1.30% 9.22% 0.10 IBM -11.36% 22.80% -0.51 1.44% 9.67% 0.11 Intel -20.08% 40.00% -0.51 2.62% 12.98% 0.17 Johnson & Johnson -15.90% 52.07% -0.31 1.40% 6.84% 0.15 McDonald’s -17.10% 22.27% -0.78 1.01% 7.40% 0.09 Merck -14.88% 31.77% -0.48 1.07% 7.46% 0.09 Microsoft -18.71% 30.90% -0.62 3.41% 8.61% 0.35 MMM -21.00% 20.08% -1.06 1.07% 6.49% 0.11 Pfizer -21.60% 23.98% -0.92 1.87% 8.41% 0.18 Procter & Gamble -19.90% 22.61% -0.90 1.33% 7.41% 0.13 Verizon -17.85% 28.71% -0.63 0.46% 6.69% 0.02 Wal-Mart -17.43% 32.85% -0.54 1.69% 8.05% 0.17 a This spread in<strong>vol</strong>ves buying one contract of the call option that has the strike price right below the stock price, and selling one contract of the call option that has the strike price right above the stock price. b The Sharpe ratio is computed by dividing the mean return on the spread less the mean return on Treasury bills by the standard deviation of return on the spread. ©2008, IARFC All rights of reproduction in any form reserved.
Volume 6, Issue 2 & 3 119 Hypothesis Testing: (1) Average Returns Wilcoxon signed rank test = 4.62 (p-value = 0.00) are equal. van der Waerden test = -4.34 (p-value = 0.00) (2) Standard Deviations Wilcoxon signed rank test = 4.62 (p-value = 0.00) are equal. van der Waerden test = 4.34 (p-value = 0.00) (3) Sharpe Ratios Wilcoxon signed rank test = 4.62 (p-value = 0.00) are equal. van der Waerden test = -4.34 (p-value = 0.00) To determine if the devastating result of the bull call spread was consistent throughout the sample period, the sample period was divided into two equal periods: one sub-sample period covering 1993-1999, and the other covering 1990-1992 and 2000-2003, combined. The first sub-period witnessed a more bullish stock market than the second, and the latter included both the recession in the early 1990s and the recent recession known as “dot com crash.” Table 3 presents the performance results for the more bullish subperiod, January 1993 through December 1999. Again the table lists the average returns, standard deviations, and the Sharpe ratios of the two strategies. The results are qualitatively identical to those reported in Table 2. For the Alcoa stock, as an example, the average monthly return on the spread is -23.69% (approximately -96.1% on an annual basis) while the average monthly return on the stock is 2.09% (approximately 28.2% on an annual basis). The standard deviations are 22.13% and 8.39%, respectively. Once again the bull call spread produced a lower average return and higher standard deviation. Obviously, the Sharpe ratio is lower for the call spread than for the stock investment. The message is clear: for the Alcoa stock, the bull call strategy did not work at all, even during the more bullish period. A bull call spread strategy using the Alcoa call options, as defined above, would have wreaked a great havoc on investors: it could have wiped out 96.1% of an investor’s wealth. Statistically, both the Wilcoxon signed rank test and van der Waerden test indicate that the average returns are significantly lower but the average standard deviations are significantly higher for the call spread. As a result, the Sharpe ratios under the call spread are significantly lower than those under the outright stock investment at the 1% level. Certainly, the investors should not have adopted the bull call spread strategy. Research & Theory
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3433-vol. 6 issue 2-3.pmd - iarfc

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