The Risk-Neutral Distribution of Option Returns
59 Pages Posted: 22 Jan 2017 Last revised: 26 Feb 2017
Date Written: January 1, 2017
This is the first study on the risk-neutral distribution of option returns. We derive solutions for the risk-neutral variance, skewness, and kurtosis of call and put option returns and document several properties of these ex-ante moments. We find that the volatility, skewness, and kurtosis of both call and put returns are higher (lower) for options that are further out-of-the-money (in-the-money). The risk-neutral moments of call returns are increasing in the volatility of the underlying security, while the opposite is true for put returns. Call return moments have strong negative time-series correlation with put return moments. We find that the magnitudes of the risk-neutral and physical moments differ substantially, indicating significant option volatility, skewness, and kurtosis risk premia. The option volatility risk premium is significantly higher than the stock volatility risk premium.
Keywords: Risk-Neutral Distribution, Option Returns
JEL Classification: G11, G12, G14, G33
Suggested Citation: Suggested Citation