A New Index of Option Implied Absolute Deviation

42 Pages Posted: 21 Jan 2021 Last revised: 18 Jan 2022

See all articles by George Dotsis

George Dotsis

National and Kapodistrian University of Athens - Faculty of Economics; Essex Finance Centre, Essex Business School, University of Essex

Date Written: January 11, 2022

Abstract

This paper proposes a new index of forward looking absolute deviation extracted from option prices. The new index, named ADIX, is model-free and easy to compute using at-the-money straddle prices. An empirical analysis using S&P 500 options data for the time period 1996-2019 reveals that ADIX embeds useful information for forecasting future realized volatility and future returns. The term structure of ADIX is consistent with the expectations hypothesis and short-term ADIX is economically significant and outperforms VIX in a mean-variance asset allocation exercise. The new index offers an alternative risk measure, more intuitive as a measure of dispersion, to study information embedded in option prices.

Keywords: straddle, option implied absolute deviation

JEL Classification: G12, G13

Suggested Citation

Dotsis, George, A New Index of Option Implied Absolute Deviation (January 11, 2022). Available at SSRN: https://ssrn.com/abstract=3728746 or http://dx.doi.org/10.2139/ssrn.3728746

George Dotsis (Contact Author)

National and Kapodistrian University of Athens - Faculty of Economics ( email )

Greece

HOME PAGE: http://sites.google.com/site/gdotsis/

Essex Finance Centre, Essex Business School, University of Essex ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

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