Long-Dated Call Options in Defined Contribution Plans

This working paper evaluates the potential of long-dated call options to address design flaws in target date funds (TDFs), which are widely used in defined contribution (DC) plans. The authors analyze historical S&P 500 data and simulated market scenarios to assess various accumulation strategies that incorporate option leverage. The study identifies two effective strategies: the Blended strategy, which converts option profits to equities immediately, and the Split Profit strategy, which conditions conversion on realized gains. Both strategies demonstrate a high frequency of outperformance compared to the S&P 500 benchmark while maintaining a risk profile similar to passive equity investments. The paper argues that option-based leverage can enhance retirement outcomes for younger participants by providing greater equity exposure during their early working years. The findings suggest that these option-enhanced strategies should be considered as viable alternatives to conventional TDF designs, which often fail to provide adequate equity exposure and downside protection throughout the investment horizon.