Stock Options as Lotteries
57 Pages Posted: 18 Mar 2011 Last revised: 21 Jun 2013
Date Written: June 20, 2013
We investigate the relationship between ex-ante total skewness and holding returns on individual equity options. Recent theoretical developments predict a negative relationship between total skewness and average returns, in contrast to the traditional view that only coskewness should be priced. We find, consistent with recent theory, that total skewness exhibits a strong and negative relationship with average option returns. The differences in average returns between low and high skewed options is large, ranging from 10 to 50 per cent per week, even after controlling for risk. Our findings suggest that these large premiums compensate intermediaries for bearing unhedgable risk when accommodating the relatively high investor demand for lottery-like options.
Keywords: options, skewness, behavioral finance
JEL Classification: G12, G13
Suggested Citation: Suggested Citation