Option Gamma and Stock Returns

Abstract

Stocks with high net gamma exposure robustly underperform stocks with low net gamma exposure by 10% per year. This effect is distinct from multiple previously documented return predictors, and survives many robustness checks. We show that stocks with low net gamma exposure negatively predicts future realized volatility. We argue that investors command a risk premium to hold low net gamma exposure stocks, which are riskier. Lastly, we show that the volatility predictability stems from a non-informational channel, and not from private information.

Keywords: Cross-section of stock returns, option demand, gamma hedging, return predictability

JEL Classification: G00, G11, G12, G14