Very Noisy Option Prices and Inferences Regarding Option Returns

56 Pages Posted: 3 Dec 2019

See all articles by Jefferson Duarte

Jefferson Duarte

Rice University

Christopher S. Jones

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Junbo L. Wang

Louisiana State University, Baton Rouge

Date Written: November 15, 2019

Abstract

We show that microstructure biases in the estimation of expected option returns and risk premia are large, in some cases over 50 basis points per day. We propose a new method that corrects for these biases. We then apply our method to real data and produce three main findings. First, the expected returns of straddles and delta-hedged options written on the S&P 500 Index are smaller than previously estimated in the literature. Second, delta-hedged options and straddles written on individual stocks have negative expected returns. Third, the price of individual equity volatility risk is about 45% of the price of market volatility. These findings show that the stylized finding that volatility is not priced in individual stock options is due to microstructure biases.

Keywords: Options, Liquidity, Microstructure bias

JEL Classification: G10,G12

Suggested Citation

Duarte, Jefferson and Jones, Christopher S. and Wang, Junbo L., Very Noisy Option Prices and Inferences Regarding Option Returns (November 15, 2019). Available at SSRN: https://ssrn.com/abstract=3488738 or http://dx.doi.org/10.2139/ssrn.3488738

Jefferson Duarte (Contact Author)

Rice University ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States
713.3486137 (Phone)

Christopher S. Jones

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

Junbo L. Wang

Louisiana State University, Baton Rouge ( email )

Baton Rouge, LA 70803
United States

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