FACULTÉ & RECHERCHE

Recent studies find that a long position in at-the-money straddles consistently yields losses. This is interpreted as evidence for the non-redundancy of options and as a risk premium for volatility risk. This article analyzes this risk premium in more detail by 1) assessing the return properties of straddle strategies and 2) analyzing their role in a portfolio context. Our findings show that only a small percentage of the variation in straddle returns can be explained by exogenous factors. In addition, when we add the straddle to a portfolio of the underlying asset and a risk-free asset, the resulting optimal portfolio attributes substantial weight to the straddle position. We also assess whether the benefits of straddles can be captured in practice. Our results show that straddles require daily rebalancing to remain beta neutral. However, certainty equivalent gains from including the straddles in a portfolio do not compensate for reasonable levels of transaction costs. Therefore, from an investor’s perspective, straddle trading does not seem to be a practically feasible way to capture the volatility risk premium.