TY - JOUR T1 - An Alternative Option to Portfolio Rebalancing JF - The Journal of Derivatives SP - 7 LP - 32 DO - 10.3905/jod.2018.25.3.007 VL - 25 IS - 3 AU - Israelov, Roni AU - Tummala, Harsha Y1 - 2018/02/28 UR - http://jod.pm-research.com/content/25/3/7.abstract N2 - Portfolio managers, whether running a passive or an active strategy, typically select target weights on the various asset classes and securities they hold. The prime example is choosing the mix between stocks and bonds. But as market prices evolve, actual weights drift away from the targets. This leads to tracking error and transaction costs in order to rebalance positions to the desired levels. Rebalancing entails selling assets that have gone up in value and increasing exposure to those whose prices have dropped. As Israelov and Tummala point out, this is how a short position in a call option behaves, and they show how to design a hedging strategy based on writing calls that offsets much of the basis risk in trying to run a portfolio with fixed asset weights. An empirical illustration shows that their proposed overlay strategy would have performed well historically in reducing unintended timing risk in a 60/40 stock/bond portfolio. An additional benefit of the plan is that by selling options, it harvests the volatility risk premium embedded in their prices, which enhances returns at the same time risk is being reduced. ER -