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Option Returns and Volatility Mispricing

38 Pages Posted: 14 Mar 2006  

Amit Goyal

University of Lausanne; Swiss Finance Institute

Alessio Saretto

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Date Written: February 2007

Abstract

We study the cross-section of stock options returns and find an economically important source of mispricing in individual equity options. Sorting stocks based on the difference between historical realized volatility and market implied volatility, we find that a zero-cost trading strategy that is long (short) in straddles, with a large positive (negative) difference in these two volatility measures, produces an economically important and statistically significant average monthly return. The results are robust to different market conditions, to firm risk-characteristics, to various industry groupings, to options liquidity characteristics, and are not explained by linear factor models.

Keywords: option returns, implied volatility

JEL Classification: C21, G13, G14

Suggested Citation

Goyal, Amit and Saretto, Alessio, Option Returns and Volatility Mispricing (February 2007). Available at SSRN: https://ssrn.com/abstract=889947 or http://dx.doi.org/10.2139/ssrn.889947

Amit Goyal

University of Lausanne ( email )

Lausanne, Vaud CH-1015
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Alessio Saretto (Contact Author)

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

800 Campbell Road
SM 31
Richardson, TX 75080
United States
972-883-5907 (Phone)

HOME PAGE: http://www.utdallas.edu/~axs125732

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