The Profitability of Option-Based Contrarian Strategies: An Empirical Analysis

Short-selling restrictions limit investors' opportunities to profit from contrarian strategies in equity markets. We examine the proposition that incorporating options into contrarian strategies constitute a viable alternative to investors when short-selling restrictions are in place. In particular, we combine equities with the call and put options traded on the Australian Stock Exchange to investigate the profitability of contrarian strategies in the hybrid market and options market alone. We assess the practical issues in the execution of these approaches, including testing for the effects of limited liquidity and transaction costs. We also investigate how fundamental factors (such as dividend yield, firm size, book-to-market ratio, earnings per share, price-earnings ratio, value stocks, and market conditions) affect contrarian portfolios. The results show that employing options can enhance the profitability of contrarian strategies under certain market conditions.