Stock Return Autocorrelations and Expected Option Returns

51 Pages Posted: 18 Apr 2019 Last revised: 16 Jul 2020

See all articles by Yoontae Jeon

Yoontae Jeon

Ryerson University - Ted Rogers School of Management

Raymond Kan

University of Toronto - Rotman School of Management

Gang Li

The Chinese University of Hong Kong, CUHK Business School

Date Written: March 31, 2019

Abstract

We present a new finding that the return autocorrelation of underlying stock is an important determinant of expected equity option returns. Using an extended Black-Scholes model incorporating the presence of stock return autocorrelation, we show that expected returns of both call and put options are increasing in return autocorrelation coefficient of the underlying stock. Consistent with this insight, we find strong empirical support in the cross-section of average returns of equity options. Average returns of calls and puts as well as average returns of straddles all show monotonically increasing relationship with the degree of underlying stock's return autocorrelation coefficient. Additional equity option portfolio analysis shows that the information on stock return autocorrelation helps investors to significantly improve the out-of-sample performance of their portfolios.

Keywords: stock return autocorrelation, expected option returns, cross-section of option returns, option portfolios

JEL Classification: G11, G12, G13

Suggested Citation

Jeon, Yoontae and Kan, Raymond and Li, Gang, Stock Return Autocorrelations and Expected Option Returns (March 31, 2019). Available at SSRN: https://ssrn.com/abstract=3363331 or http://dx.doi.org/10.2139/ssrn.3363331

Yoontae Jeon

Ryerson University - Ted Rogers School of Management ( email )

350 Victoria Street
Toronto, Ontario M5B 2K3
Canada

Raymond Kan

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S3E6
Canada
416-978-4291 (Phone)
416-971-3048 (Fax)

Gang Li (Contact Author)

The Chinese University of Hong Kong, CUHK Business School ( email )

Shatin, N.T.
Hong Kong
Hong Kong

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