Common Factors in Equity Option Returns

51 Pages Posted: 7 Dec 2018

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); Tinbergen Institute

Date Written: November 20, 2018

Abstract

This paper studies the factor structure in the cross-section of delta-hedged equity option returns. Using latent factor techniques, we find strong evidence for the existence of a factor structure in equity options returns. We propose a four-factor model, which captures relevant latent factors and explains the time series and cross-section of equity option returns. The factors are the market volatility risk factor and three characteristic-based factors related to firm size, idiosyncratic volatility, and the difference between implied and historical volatilities. 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 20, 2018). 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

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Register to save articles to
your library

Register

Paper statistics

Downloads
65
rank
326,609
Abstract Views
232
PlumX Metrics