We provide evidence that trading frictions have an economically important impact oil the execution and the profitability of option strategies that involve writing out-of-the-money put options. Margin requirements, in particular, limit the notional amount of capital that can be invested in the strategies and force investors to close down positions and realize losses. The economic effect of frictions is stronger when the investor seeks to write options more aggressively. Although margins are effective in reducing counterparty default risk, they also impose a friction that limits investors from supplying liquidity to the option market. (C) 2009 Elsevier B.V. All rights reserved.
- Limits to arbitrage
- Option strategies