Volatility Uncertainty and the Cross-Section of Option Returns

53 Pages Posted: 25 May 2018 Last revised: 5 Jun 2019

See all articles by Jie Cao

Jie Cao

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

Aurelio Vasquez

Instituto Tecnológico Autónomo de México (ITAM) - Department of Business Administration

Xiao Xiao

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Erasmus Research Institute of Management (ERIM)

Xintong Zhan

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

Date Written: December 20, 2018

Abstract

Volatility of stock return is time varying. We find that the options of stocks with higher uncertainty of volatility change are more expensive, as indicated by lower future delta-hedged option returns. Specifically, option writers charge a higher (lower) premium for options with a higher magnitude of increase (decrease) in the implied volatility. Option market makers or dealers also charge a high premium for options with high uncertainty of realized volatility because these options are more difficult to price or hedge. However, there is little evidence that the speculative investors’ preferences on the uncertainty of volatility drive up the option price.

Keywords: Delta-hedged option returns; volatility estimates; uncertainty of volatility

JEL Classification: G12, G1

Suggested Citation

Cao, Jie and Vasquez, Aurelio and Xiao, Xiao and Zhan, Xintong, Volatility Uncertainty and the Cross-Section of Option Returns (December 20, 2018). Available at SSRN: https://ssrn.com/abstract=3178263 or http://dx.doi.org/10.2139/ssrn.3178263

Jie Cao (Contact Author)

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

Aurelio Vasquez

Instituto Tecnológico Autónomo de México (ITAM) - Department of Business Administration ( email )

Rio Hondo No. 1
Col. Tizapan-San Angel, 01000
Mexico

Xiao Xiao

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

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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