Understanding Index Option Returns

54 Pages Posted: 21 May 2008

See all articles by Mark Broadie

Mark Broadie

Columbia University - Columbia Business School - Decision Risk and Operations

Mikhail Chernov

UCLA Anderson

Michael S. Johannes

Columbia Business School - Finance and Economics

Multiple version iconThere are 4 versions of this paper

Date Written: May 2007


This paper studies the returns from investing in index options. Previous research documents significant average option returns, large CAPM alphas, and high Sharpe ratios, and concludes that put options are mispriced. We propose an alternative approach to evaluate the significance of option returns and obtain different conclusions. Instead of using these statistical metrics, we compare historical option returns to those generated by commonly used option pricing models. We find that the most puzzling finding in the existing literature, the large returns to writing out-of-the-money puts, is not even inconsistent with the Black-Scholes model. Moreover, simple stochastic volatility models with no risk premia generate put returns across all strikes that are not inconsistent with the observed data. At-the-money straddle returns are more challenging to understand, and we find that these returns are not inconsistent with explanations such as jump risk premia, Peso problems, and estimation risk.

Keywords: jump risk premia, jump-diffusion models, options returns, put pricing puzzle

JEL Classification: C13, G12, G13

Suggested Citation

Broadie, Mark and Chernov, Mikhail and Johannes, Michael Slater, Understanding Index Option Returns (May 2007). CEPR Discussion Paper No. DP6239, Available at SSRN: https://ssrn.com/abstract=1135477

Mark Broadie (Contact Author)

Columbia University - Columbia Business School - Decision Risk and Operations ( email )

New York, NY
United States
212-854-4103 (Phone)

Mikhail Chernov

UCLA Anderson ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Michael Slater Johannes

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

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