Firm Specific Option Risk and Implications for Asset Pricing

Journal of Risk Vol 12, No.1, pp.17-52, Fall 2009

37 Pages Posted: 29 Sep 2007 Last revised: 3 Aug 2010

See all articles by James Doran

James Doran

University of New South Wales

Andy Fodor

Ohio University

Date Written: September 21, 2007

Abstract

This paper examines the benefits and costs of investing in firm specific options as an additional investment in a portfolio. We examine twelve option strategies and find that there is significant negative (positive) abnormal return to buying (selling) puts from January 1996 through July 2006. There is almost no additional benefit from going long any option, and some benefit from selling calls, dependent on the amount option leverage taken. Additionally, we find that the premiums from selling puts are not related to any specific firm characteristic, suggesting a pervasive premium for puts. Asset pricing tests that include market option return factors are unable to explain the returns to firm specific options. Tests on delta-hedged portfolios confirm that the gains to puts are related to idiosyncratic volatility and not market volatility. This is indicative an idiosyncratic volatility risk premium that is distinct from idiosyncratic price risk.

Keywords: Option Prices, Idiosyncratic Volatility Risk, Portfolio Returns

JEL Classification: G11, G12

Suggested Citation

Doran, James and Fodor, Andy, Firm Specific Option Risk and Implications for Asset Pricing (September 21, 2007). Journal of Risk Vol 12, No.1, pp.17-52, Fall 2009, Available at SSRN: https://ssrn.com/abstract=1017862

James Doran (Contact Author)

University of New South Wales ( email )

College Rd
Sydney, NSW 2052
Australia

Andy Fodor

Ohio University ( email )

514 Copeland Hall
Athens, OH 45701
United States
740.593.0259 (Phone)

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