Understanding Index Option Returns

Posted: 8 Dec 2009

See all articles by Mark Broadie

Mark Broadie

Columbia University - Columbia Business School - Decision Risk and Operations

Mikhail Chernov

UCLA Anderson

Multiple version iconThere are 4 versions of this paper

Date Written: November 2009


Previous research concludes that options are mispriced based on the high average returns, CAPM alphas, and Sharpe ratios of various put selling strategies. One criticism of these conclusions is that these benchmarks are ill suited to handle the extreme statistical nature of option returns generated by nonlinear payoffs. We propose an alternative way to evaluate the statistical significance of option returns by comparing historical statistics to those generated by option pricing models. The most puzzling finding in the existing literature, the large returns to writing out-of-the-money puts, is not inconsistent (i.e., is statistically insignificant) relative to the Black-Scholes model or the Heston stochastic volatility model due to the extreme sampling uncertainty associated with put returns. This sampling problem can largely be alleviated by analyzing market-neutral portfolios such as straddles or delta-hedged returns. The returns on these portfolios can be explained by jump risk premiums and estimation risk.

JEL Classification: C12, G13

Suggested Citation

Broadie, Mark and Chernov, Mikhail, Understanding Index Option Returns (November 2009). The Review of Financial Studies, Vol. 22, Issue 11, pp. 4493-4529, 2009, Available at SSRN: https://ssrn.com/abstract=1519274 or http://dx.doi.org/hhp032

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

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