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Expected Option Returns

35 Pages Posted: 5 Nov 1999  

Tyler Shumway

University of Michigan at Ann Arbor, The Stephen M. Ross School of Business

Joshua D. Coval

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2000

Abstract

This paper examines expected option returns in the context of mainstream asset pricing theory. Under mild assumptions, call options have expected returns which exceed those of their underlying security and which are increasing in their strike prices. Likewise, put options have expected returns which are below the risk-free rate and which are also increasing in their strike prices. Across a variety of time periods and return frequencies, S&P 500 and 100 index option returns strongly exhibit these characteristics. Under stronger assumptions, expected option returns are a linear function of option betas. Fama-MacBeth-style option return regressions produce risk premia close to the expected market return. However, the regression intercepts are significantly below zero. As a result, zero-beta, at-the-money straddle positions produce average losses of approximately three percent per week. Zero-beta straddles in other markets also lose money consistently. These findings suggest that some additional factor, such as systematic stochastic volatility, is priced in option returns.

JEL Classification: G12, G13

Suggested Citation

Shumway, Tyler and Coval, Joshua D., Expected Option Returns (June 2000). Available at SSRN: https://ssrn.com/abstract=189840 or http://dx.doi.org/10.2139/ssrn.189840

Tyler Shumway (Contact Author)

University of Michigan at Ann Arbor, The Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-763-4129 (Phone)
734-936-0274 (Fax)

HOME PAGE: http://www.umich.edu/~shumway

Joshua D. Coval

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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