Option-Implied Spreads and Option Risk Premia

44 Pages Posted: 23 Jun 2021

See all articles by Christopher L. Culp

Christopher L. Culp

John Hopkins University, School of Advanced International Studies

Mihir Gandhi

University of Chicago - Booth School of Business

Yoshio Nozawa

University of Toronto

Pietro Veronesi

University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: June 22, 2021

Abstract

We propose implied spreads (IS) and normalized implied spreads (NIS) as simple measures to characterize option prices. IS is the credit spread of an option’s implied bond, the portfolio long a risk-free bond and short a put option. NIS normalizes IS by the risk-neutral default probability and reflects tail risk. IS and NIS are countercyclical and predict implied bond returns, while neither, like implied volatility, predicts put returns. These opposite predictability results are consistent with a stochastic volatility, stochastic jump intensity model, as put premia increase in volatility but decrease in jump intensity, while implied bond premia increase in both.

JEL Classification: G12,G13

Suggested Citation

Culp, Christopher L. and Gandhi, Mihir and Nozawa, Yoshio and Veronesi, Pietro, Option-Implied Spreads and Option Risk Premia (June 22, 2021). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2021-71, Available at SSRN: https://ssrn.com/abstract=3872048 or http://dx.doi.org/10.2139/ssrn.3872048

Christopher L. Culp

John Hopkins University, School of Advanced International Studies ( email )

Mihir Gandhi

University of Chicago - Booth School of Business ( email )

5807 S Woodlawn Ave
Chicago, IL 60637
United States

Yoshio Nozawa

University of Toronto ( email )

105 St George St
Toronto, ON M5S3E6
Canada
3013125569 (Phone)

Pietro Veronesi (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-6348 (Phone)
773-702-0458 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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