Mental Accounting: A New Behavioral Explanation of Covered Call Performance

Siddiqi, Hammad (2014). Mental Accounting: A New Behavioral Explanation of Covered Call Performance. Working Paper: F14_2, School of Economics, The University of Queensland.

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Author Siddiqi, Hammad
Title Mental Accounting: A New Behavioral Explanation of Covered Call Performance
School, Department or Centre School of Economics
Institution The University of Queensland
Open Access Status Other
Report Number Working Paper: F14_2
Publication date 2014-01-15
Publisher Schools of Economics and Political Science
Total pages 17
Language eng
Formatted abstract
The empirical performance of covered call writing is quite puzzling in the traditional finance framework. Covered call writing is typically a risk reducing strategy so its expected return should be less than the expected return on the underlying in an efficient market. However, recent empirical evidence suggests (covering a period from 1988 onwards) that the covered call writing has nearly the same return as the underlying whereas the standard deviation of returns is considerably less. Market professionals consider a call option to be a surrogate for the underlying. Such mental accounting of a call option with the underlying has strong support in laboratory experiments. We show that such mental accounting embodied in the principle, assets with similar payoffs must have the same expected returns, provides a new behavioral explanation for the puzzling empirical performance of covered call writing.
Keyword Covered Call
Generalized Principle of No Arbitrage
Analogy making
Mental accounting
Binomial Model
Trinomial Model
Black Scholes
Q-Index Status Provisional Code
Institutional Status UQ

Document type: Working Paper
Collection: School of Economics Publications
 
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Created: Fri, 12 Dec 2014, 15:36:02 EST by Hammad Siddiqi on behalf of School of Economics