Publication Type
Working Paper
Version
publishedVersion
Publication Date
2-2016
Abstract
We show the cross-section of equity option returns can be predicted by a variety of underlying stock characteristics and firm fundamentals, including idiosyncratic volatility, past stock returns, profitability, cash holding, new share issuance, and dispersion of analyst forecasts. Such predictability is not mechanically inherited from the stock market because these variables do not significantly predict stock returns in our sample, and our results hold for delta-hedged calls and puts in the same directions. We document new option trading strategies that are profitable even after transaction costs. These profits are robust across different market conditions and subsamples. They cannot be explained by existing stock market risk factors including market volatility risk or tail risk, or individual stock volatility risk premium, jump risk and option illiquidity. These systematic patterns in the relative valuation of options and the underlying stocks have important implications for option valuation and option market efficiency.
Keywords
Equity option returns, delta-neutral call writing, stock return predictors
Discipline
Corporate Finance | Finance and Financial Management
Research Areas
Finance
Publisher
Rotman School of Management Working, Paper No. 2698267
City or Country
Toronto
Citation
CAO, Jie; BING, Han; TONG, Qing; and ZHAN, Xintong.
Option Return Predictability. (2016).
Available at: https://ink.library.smu.edu.sg/lkcsb_research/4907
Creative Commons License
This work is licensed under a Creative Commons Attribution-NonCommercial-No Derivative Works 4.0 International License.
Additional URL
https://ssrn.com/abstract=2698267