Margin Requirements and Equity Option Returns
52 Pages Posted: 4 Jun 2016 Last revised: 4 Nov 2016
Date Written: November 3, 2016
In equity option markets, traders face margin requirements both for the options themselves and for hedging-related positions in the underlying stock market. We show that these requirements carry a significant margin premium in the cross-section of equity option returns. The sign of the margin premium depends on demand pressure: If end-users are on the long side of the market, option returns decrease with margins, while they increase otherwise. Our results are statistically and economically significant and robust to different margin specifications and various control variables. We explain our findings by a model of funding-constrained derivatives dealers that require compensation for satisfying end-users’ option demand.
Keywords: equity options, margins, funding liquidity, cross-section of option returns
JEL Classification: G12, G13
Suggested Citation: Suggested Citation