A margin requirement based return calculation for portfolios of short option positions

Purpose – Short option positions carry significant risk of losses well in excess of 100 per cent of the initial option price. Margin requirements associated with such positions are therefore considerable. The purpose of this paper is to develop a methodology for calculating margin requirement‐based option portfolio returns that realistically represent the returns realized by investors, and to demonstrate the effects of this methodology on analyses of option returns. Design/methodology/approach – A methodology is developed for calculating margin requirement‐based short option portfolio returns. Findings – Accounting for margin requirements reduces the returns of simple short option strategies by up to 92 per cent compared to the price return. In long/short portfolio analyses, use of margin requirement returns necessitates additional methodological adjustments to ensure that unwanted volatility risk is properly hedged. Originality/value – The result is a portfolio return that more accurately represents the return realized by investors, and increased power to detect cross‐sectional patterns in option returns.