Improving Portfolio Selection Using Option-Implied Volatility and Skewness

Portfolio performance is measured in terms of four metrics: volatility, Sharpe ratio, certainty-equivalent return and turnover. Our empirical evidence shows that, while using option-implied volatility and correlation does not significantly improve the portfolio volatility, Sharpe ratio and certainty-equivalent return, exploiting information contained in the volatility risk premium and option- implied skewness substantially increases both the Sharpe ratio and certainty- equivalent return, although this is accompanied by higher turnover. Moreover, the volatility risk premium and option-implied skewness help improve not just the performance of mean-variance portfolios, but also the performance of parametric portfolios developed in Brandt, Santa-Clara and Valkanov (2009).