The Effect of Option-implied Skewness on Delta- and Vega-Hedged Option Returns
42 Pages Posted: 29 Jul 2019 Last revised: 17 Jan 2020
Date Written: January 16, 2020
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: Suggested Citation