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 options and how options affect portfolio performance and risk. Options users underperform nonusers by two to three percent per year. The underperformance is especially pronounced for funds that are heavy users of options and employ directional strategies. These findings disprove the claim that mutual funds that use options have either superior talent or possess better information, which they try to leverage in the options market. Additional analysis suggests that active hedging or riskneutral strategies, rather than active risk-taking, is a more likely reason why mutual funds use options.