Option Return Predictability

66 Pages Posted: 6 Dec 2015 Last revised: 8 Jun 2020

See all articles by Jie Cao

Jie Cao

The Chinese University of Hong Kong (CUHK) - CUHK Business School

Bing Han

University of Toronto, Rotman School of Management

Qing Tong

School of Business, Renmin University of China

Xintong Zhan

The Chinese University of Hong Kong (CUHK) - CUHK Business School

Date Written: June 6, 2020

Abstract

We uncover new return predictability in the cross-section of delta-hedged equity options. Expected returns of writing delta-hedged calls are negatively correlated with current stock price, firm profit margin and profitability, but positively correlated with firm cash holding, cash flow variance, new shares issuance, total external financing, distress risk, and dispersion of analyst forecasts. We develop ten option portfolio strategies that have annual Sharpe ratios above three and remain profitable after transaction costs. Their profits can be explained by two new option factors although stock market risk factors have little explanatory power. We examine the economic channels underlying option return predictability.

Keywords: Cross-section of equity options; delta-neutral call writing; return predictability; stock characteristics; option factor model

JEL Classification: G02, G12, G13

Suggested Citation

Cao, Jie and Han, Bing and Tong, Qing and Zhan, Xintong, Option Return Predictability (June 6, 2020). 27th Annual Conference on Financial Economics and Accounting Paper, Rotman School of Management Working Paper No. 2698267, Available at SSRN: https://ssrn.com/abstract=2698267 or http://dx.doi.org/10.2139/ssrn.2698267

Jie Cao

The Chinese University of Hong Kong (CUHK) - CUHK Business School ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Shatin, NT
Hong Kong
(852) 3943 7757 (Phone)
(852) 2603 6586 (Fax)

HOME PAGE: http://sites.google.com/site/jiejaycao

Bing Han (Contact Author)

University of Toronto, Rotman School of Management ( email )

Toronto, Ontario M5S 3E6
Canada
4169460732 (Phone)

Qing Tong

School of Business, Renmin University of China ( email )

Beijing
China

Xintong Zhan

The Chinese University of Hong Kong (CUHK) - CUHK Business School ( email )

Cheng Yu Tung Building
Shatin, NT
Hong Kong

HOME PAGE: http://sites.google.com/view/xintongzhan

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