Option Return Predictability

78 Pages Posted: 6 Dec 2015 Last revised: 1 Mar 2022

See all articles by Xintong Zhan

Xintong Zhan

Department of Finance, School of Management, Fudan University

Bing Han

University of Toronto, Rotman School of Management

Jie Cao

The Hong Kong Polytechnic University - School of Accounting and Finance

Qing Tong

Shanghai LiLi Technology Co.,Ltd.

Date Written: February 2, 2021

Abstract

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

Zhan, Xintong and Han, Bing and Cao, Jie and Tong, Qing, Option Return Predictability (February 2, 2021). Review of Financial Studies, Vol. 35, 2022, 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

Xintong Zhan

Department of Finance, School of Management, Fudan University ( email )

No. 670, Guoshun Road
No.670 Guoshun Road
Shanghai, 200433
China

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

Bing Han (Contact Author)

University of Toronto, Rotman School of Management ( email )

Toronto, Ontario M5S 3E6
Canada
4169460732 (Phone)

Jie Cao

The Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom, Kowloon
Hong Kong

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

Qing Tong

Shanghai LiLi Technology Co.,Ltd. ( email )

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