A New Option Momentum: Compensation for Risk

53 Pages Posted: 28 Sep 2023 Last revised: 28 Jun 2024

See all articles by Heiner Beckmeyer

Heiner Beckmeyer

University of Münster

Ilias Filippou

Washington University in St. Louis - John M. Olin Business School

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School

Date Written: March 29, 2023

Abstract

This paper introduces a novel momentum strategy in the options market based on the systematic component of option returns. Utilizing a latent factor model to decompose options returns, we demonstrate that the systematic component exhibits stronger momentum and subsumes the performance of conventional return-based momentum. With a six-month formation and one-month holding period, the strategy achieves an annualized Sharpe ratio of 2.23, compared to 1.08 for traditional momentum, and is highly profitable for various formation and holding periods. The superior performance is driven by time-varying risk compensation rather than investor biases, underscoring the economic rationale behind its success.

Keywords: Option, Momentum, Factor Risk, Limits to Arbitrage JEL classification: G11, G12, G14, G40

JEL Classification: G11, G12, G14, G40.

Suggested Citation

Beckmeyer, Heiner and Filippou, Ilias and Zhou, Guofu, A New Option Momentum: Compensation for Risk (March 29, 2023). Available at SSRN: https://ssrn.com/abstract=4404190 or http://dx.doi.org/10.2139/ssrn.4404190

Heiner Beckmeyer

University of Münster ( email )

Schlossplatz 2
Muenster, D-48143
Germany

HOME PAGE: http://heinerbeckmeyer.com

Ilias Filippou (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School ( email )

Washington University
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6384 (Phone)
314-658-6359 (Fax)

HOME PAGE: http://apps.olin.wustl.edu/faculty/zhou/

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