The Role of Options in Goals-Based Wealth Management

Vol.21, No.1, 2023
by Sanjiv R. Das and Greg Ross

We develop a methodology using dynamic programming for goals-based wealth management over long horizons where portfolio rebalancing uses the standard securities and also derivative securities. A kernel density estimation approach is developed to accommodate derivative assets, solving a high-dimensional problem with fast computation. The approach accommodates skewed and fat-tailed distributions. Portfolio performance is better with the use of options, especially for investors with aggressive goals. The improved performance arises because options unlock additional leverage, which is useful for reaching upside goals. Calls are preferred to puts unless upside goals are modest. The framework is extensible with periodic withdrawals and multiple goals, while being cognizant of downside risk.

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