Common Factors in Equity Option Returns

51 Pages Posted: 7 Dec 2018 Last revised: 24 Dec 2019

See all articles by Alex R. Horenstein

Alex R. Horenstein

University of Miami - School of Business Administration - Department of Economics

Aurelio Vasquez

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

Xiao Xiao

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

Date Written: November 26, 2019

Abstract

This paper studies the factor structure of the cross-section of delta-hedged equity option returns. We find that a four-factor model explains the cross-section and time-series of equity option returns. Out of the four factors, three are characteristic based factors from the long-short option portfolios based on firm size, idiosyncratic volatility, and the difference between implied and historical volatilities. The fourth factor is the market volatility risk factor proxied by the delta-hedged option return of the the S&P 500 index. Traditional stock return factors cannot price the cross-section of equity option returns.

Keywords: Cross Section of Option Returns, Latent Factors, Rank Estimation

JEL Classification: C14, G13, G17

Suggested Citation

Horenstein, Alex R. and Vasquez, Aurelio and Xiao, Xiao, Common Factors in Equity Option Returns (November 26, 2019). Available at SSRN: https://ssrn.com/abstract=3290363 or http://dx.doi.org/10.2139/ssrn.3290363

Alex R. Horenstein (Contact Author)

University of Miami - School of Business Administration - Department of Economics ( email )

P.O. Box 248126
Coral Gables, FL 33124-6550
United States

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

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