Investor Preferences for Futures Straddles

Extract

This paper analyzed the issue of why large commodity futures traders hold a large percentage of their portfolios in straddle positions where, for the most part, such behavior implies that they are holding assets with negative expected returns. It showed that an earlier paper by Schrock [2], which suggested that such behavior provided a means by which investors could enhance their risk-return tradeoffs, provided only a partial explanation for this behavior which, in a world of positive interest rates, held only under fairly restrictive conditions. Thus, it went on to develop a more general result which strongly suggests that differentially low margin requirements on straddle positions provide a strong incentive in a world of positive interest rates for investors to hold commodity straddle positions. With some modification the model developed in this paper can be used to derive similar conclusions for certain classes of transactions in the stock options market.