Volatility and Expected Option Returns
43 Pages Posted: 27 Nov 2015 Last revised: 15 Jul 2017
Date Written: June 13, 2017
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 strongly 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 it is robust to alternative measures of underlying volatility and different weighting methods.
Keywords: expected option returns, volatility, cross-section of option returns
JEL Classification: G12
Suggested Citation: Suggested Citation