Volatility Uncertainty and the Cross-Section of Option Returns
53 Pages Posted: 25 May 2018 Last revised: 5 Jun 2019
Date Written: December 20, 2018
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: Suggested Citation