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Volatility and Expected Option Returns

Published online by Cambridge University Press:  17 April 2019

Guanglian Hu  and
Kris Jacobs
Guanglian Hu
Affiliation:
Hu, guanglian.hu@sydney.edu.au, University of Sydney Business School Discipline of Finance
Kris Jacobs*
Affiliation:
Jacobs, kjacobs@bauer.uh.edu, University of Houston Bauer College of Business
*
Jacobs (corresponding author), kjacobs@bauer.uh.edu
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Abstract

We analyze the relation between expected option returns and the volatility of the underlying securities. The expected return from holding a call (put) option is a decreasing (increasing) function of the volatility of the underlying. These predictions are supported by the data. In the cross section of equity option returns, returns on call (put) option portfolios decrease (increase) with underlying stock volatility. This finding is not due to cross-sectional variation in expected stock returns. It holds in various option samples with different maturities and moneyness, and is robust to alternative measures of underlying volatility and different weighting methods.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 3 , May 2020 , pp. 1025 - 1060
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2019

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Footnotes

We thank Torben Andersen, Michael Anderson, David Bates, Jay Cao, Hui Chen, Peter Christoffersen, Stefano Della Corta, Christian Dorion, Hitesh Doshi, Bjorn Eraker, Jan Ericsson, J.-S. Fontaine, Mathieu Fournier, Amit Goyal, Bing Han, Markus Huggenberger, Travis Johnson, Matthew Linn, Rui Liu, Dmitriy Muravyev, Benno Nguyen, Neil Pearson, Alessio Saretto, Gustavo Schwenkler, Viktor Todorov, Aurelio Vasquez, Liuren Wu, Chu Zhang, seminar participants at UMass, the 2016 China International Conference on Finance, the 2015 SFS Cavalcade, the 2016 IFSID Derivatives, 2016 MFA and 2017 FMA International Conferences, the 2016 Johns Hopkins Carey Business School Conference on the role of Derivatives in Asset Pricing, and especially Gurdip Bakshi, Scott Murray, Bruno Feunou, and Nikunj Kapadia for helpful comments.

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