Option Return Predictability

80 Pages Posted: 6 Dec 2015 Last revised: 15 Mar 2021

See all articles by Jie Cao

Jie Cao

The Chinese University of Hong Kong (CUHK) - CUHK Business School

Bing Han

University of Toronto, Rotman School of Management

Xintong Zhan

The Chinese University of Hong Kong (CUHK) - CUHK Business School

Qing Tong

Shanghai LiLi Technology Co.,Ltd.

Date Written: February 2, 2021

Abstract

We uncover new return predictability in the cross-section of delta-hedged equity options. Expected returns to writing delta-hedged calls are negatively correlated with stock price, profit margin and firm profitability, but positively correlated with cash holding, cash flow variance, new shares issuance, total external financing, distress risk, and dispersion of analyst forecasts. Our option portfolio strategies have annual Sharpe ratio above two and remain profitable after transaction costs. Their profits can be explained by two option factors while equity risk factors have no explanatory power. We find support for several economic channels at work, yet the option return predictabilities remain puzzling.

Keywords: Cross-section of equity options; delta-hedged options; return predictability; stock characteristics; option factor model

JEL Classification: G02, G12, G13

Suggested Citation

Cao, Jie and Han, Bing and Zhan, Xintong and Tong, Qing, Option Return Predictability (February 2, 2021). Review of Financial Studies accepted, 27th Annual Conference on Financial Economics and Accounting Paper, Rotman School of Management Working Paper No. 2698267, Available at SSRN: https://ssrn.com/abstract=2698267 or http://dx.doi.org/10.2139/ssrn.2698267

Jie Cao

The Chinese University of Hong Kong (CUHK) - CUHK Business School ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Shatin, NT
Hong Kong
(852) 3943 7757 (Phone)
(852) 2603 6586 (Fax)

HOME PAGE: http://sites.google.com/site/jiejaycao

Bing Han (Contact Author)

University of Toronto, Rotman School of Management ( email )

Toronto, Ontario M5S 3E6
Canada
4169460732 (Phone)

Xintong Zhan

The Chinese University of Hong Kong (CUHK) - CUHK Business School ( email )

Cheng Yu Tung Building
Shatin, NT
Hong Kong
(852) 3943-4179 (Phone)

HOME PAGE: http://sites.google.com/view/xintongzhan

Qing Tong

Shanghai LiLi Technology Co.,Ltd. ( email )

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