A Novel Approach of Option Portfolio Construction Using the Kelly Criterion

Money management is one of the most important issues in financial trading. Many skills of money managements are based on the Kelly criterion, which is a theoretical optimization of bidding an optimal fraction for position sizing. However, there is still a large gap between the theory and the real trading for money management. In this paper, we design an option trading strategy via Kelly criterion. While the price movements of options are highly volatile, various options' portfolio can be formed by long or short at different strike prices to pre-lock the losses and profits; then we have a fixed profit and loss distribution via holding an option portfolio. Consequently, the Kelly criterion can be applied to the options' trading for calculating the optimal bidding fraction. We propose a method for option trading, in finding the profitable option portfolio by bidding optimal fraction. Compared with prior works, our proposed model is a novel approach for options' trading with the money management of position sizing. Experiments are conducted to show the feasibility and profitability of our method in practical scenarios. Future works are provided in the final section.