The Effect of Option-implied Skewness on Delta- and Vega-Hedged Option Returns

42 Pages Posted: 29 Jul 2019 Last revised: 17 Jan 2020

See all articles by Paul Borochin

Paul Borochin

University of Miami - Department of Finance

Zekun Wu

University of Connecticut

Yanhui Zhao

University of Wisconsin - Whitewater - College of Business and Economics

Date Written: January 16, 2020

Abstract

We study the relation between option-implied skewness (IS) and the cross-section of option returns under daily hedging to better understand the pricing of skewness in isolation from lower moments. Creating portfolios of delta-hedged (D-hedged) and delta-vega-hedged (DV-hedged) options with daily rebalancing, we find that IS is negatively related to both D-hedged and DV-hedged call option returns, but has no significant relation to hedged put option returns. The negative relation observed between IS and hedged call option returns is stronger when the underlying stock has a larger market beta, and when the firm is more opaque. Our results suggest that the relation between IS and call option portfolio returns is driven primarily by investors' skewness preference which grows stronger with larger market risk and lower information quality.

Keywords: Risk Neutral Skewness; Options; Return Predictability

JEL Classification: G12, G13

Suggested Citation

Borochin, Paul and Wu, Zekun and Zhao, Yanhui, The Effect of Option-implied Skewness on Delta- and Vega-Hedged Option Returns (January 16, 2020). Available at SSRN: https://ssrn.com/abstract=3426557 or http://dx.doi.org/10.2139/ssrn.3426557

Paul Borochin (Contact Author)

University of Miami - Department of Finance ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States

Zekun Wu

University of Connecticut ( email )

Storrs, CT
United States

Yanhui Zhao

University of Wisconsin - Whitewater - College of Business and Economics ( email )

Whitewater, WI 53190
United States

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