On the Use of Options by Mutual Funds:Do They Know What They Are Doing?

Using detailed holdings of exchange-traded options, we examine how mutual funds use optionsand how options affect portfolio performance and risk. Options users underperform nonusers bytwo to three percent per year. The underperformance is especially pronounced for funds that areheavy users of options and employ directional strategies. These findings disprove the claim thatmutual funds that use options have either superior talent or possess better information, which theytry to leverage in the options market. Additional analysis suggests that active hedging or riskneutralstrategies, rather than active risk-taking, is a more likely reason why mutual funds useoptions.