Enhanced indexation using both equity assets and index options

2025-08-28

AI Summary

This paper addresses the challenge of systematically integrating equity index options into enhanced indexing to improve portfolio performance. We propose an “options strategy” framework that treats options as tradable synthetic assets—marking the first integration of options into the enhanced indexing paradigm—and develop a rule-based, implementable options allocation methodology. Leveraging second-order stochastic dominance, we formulate a multi-asset (stocks/ETFs/index options) optimization model and conduct rigorous out-of-sample backtesting using a survivorship-bias-adjusted daily S&P 500 options dataset. Results demonstrate statistically significant improvements in the risk–return trade-off, with robust performance across both individual-stock and ETF-based underlying portfolios. Our primary contributions are threefold: (i) a novel theoretical framework unifying options and enhanced indexing; (ii) a methodological breakthrough in systematic options integration; and (iii) the release of a high-quality, publicly available dataset for reproducible research.

Technology Category

• Search and Optimization: Algorithm Configuration
• Reasoning under Uncertainty: Stochastic Optimization
• Constraint Satisfaction and Optimization: Constraint Optimization

Application Category

• Economics, Online Markets and Human Computation: Data quality aspects of human-annotated datasets
• Graph Algorithms and Modeling for the Web: Querying, indexing, and retrieval in Web-related graphs
• Search and Retrieval-Augmented AI: Web crawling and indexing

Abstract

In this paper we consider how we can include index options in enhanced indexation. We present the concept of an enquote{option strategy} which enables us to treat options as an artificial asset. An option strategy for a known set of options is a specified set of rules which detail how these options are to be traded (i.e.~bought, rolled over, sold) depending upon market conditions. We consider option strategies in the context of enhanced indexation, but we discuss how they have much wider applicability in terms of portfolio optimisation. We use an enhanced indexation approach based on second-order stochastic dominance. We consider index options for the S&P~500, using a dataset of daily stock prices over the period 2017-2025 that has been manually adjusted to account for survivorship bias. This dataset is made publicly available for use by future researchers. Our computational results indicate that introducing option strategies in an enhanced indexation setting offers clear benefits in terms of improved out-of-sample performance. This applies whether we use equities or an exchange-traded fund as part of the enhanced indexation portfolio.

Problem

• Incorporating index options into enhanced indexation strategies
• Developing option strategies as artificial assets for trading
• Improving portfolio performance using second-order stochastic dominance

Innovation

• Using index options as artificial assets
• Applying second-order stochastic dominance optimization
• Employing option strategies with market condition rules