In Search of a Factor Model for Optionable Stocks
150 Pages Posted: 1 Dec 2019 Last revised: 6 Feb 2021
Date Written: February 1, 2021
We propose the first factor model that explains cross-sectional variation in optionable stock returns. Our model includes new factors based on option-implied volatility minus realized volatility, the call minus put implied volatility spread, and the difference between changes in call and put implied volatilities. The model outperforms previously-proposed factor models at explaining the performance of portfolios of optionable stocks formed by sorting on other option-based predictors, as well as other well-known stock return predictors. The predictive power of the option-based factors is driven by informed trading and their exposures to aggregate volatility and financial uncertainty.
Keywords: Optionable stocks, factor model, cross section of stock returns
JEL Classification: G11, G12, G13
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