How can the Sharpe ratio be manipulated?

The Sharpe ratio measures the risk-adjusted return of an investment, which is calculated by taking the excess return of the asset over the risk-free rate and dividing it by the standard deviation of the asset's returns. The manipulation of the Sharpe ratio can occur through certain actions that impact either the numerator or the denominator of this ratio.

Writing out-of-the-money calls and puts affects the numerator by potentially increasing the excess return of the investment. This option involves taking on a strategy that can generate additional income through option premiums, which can enhance returns without necessarily increasing the underlying investment risk proportionately. While this might technically improve the Sharpe ratio by boosting the numerator (return), the risk may not increase in line with the increase in return, thus creating a misleadingly favorable Sharpe ratio if the risk is not fully accounted for.

In contrast, increasing the reporting frequency may lead to higher apparent volatility in returns, thus affecting the denominator negatively. Reducing total capital employed does not directly enhance returns and may alter risk metrics rather than improving the Sharpe ratio. Diversifying investments evenly is generally considered a sound investment strategy to manage risk and does not specifically manipulate the Sharpe ratio.

Understanding how certain actions can influence either component of the Sharpe ratio helps identify