Option Return Predictability
Review of Financial Studies, Vol. 35, 2022
78 Pages Posted: 6 Dec 2015 Last revised: 1 Mar 2022
Date Written: February 2, 2021
We uncover new return predictability in the cross-section of delta-hedged equity options. Expected returns to writing delta-hedged calls are negatively correlated with stock price, profit margin and firm profitability, but positively correlated with cash holding, cash flow variance, new shares issuance, total external financing, distress risk, and dispersion of analyst forecasts. Our option portfolio strategies have annual Sharpe ratio above two and remain profitable after transaction costs. Their profits can be explained by two option factors while equity risk factors have no explanatory power. We find support for several economic channels at work, yet the option return predictabilities remain puzzling.
Keywords: Cross-section of equity options; delta-hedged options; return predictability; stock characteristics; option factor model
JEL Classification: G02, G12, G13
Suggested Citation: Suggested Citation