Option-Implied Spreads and Option Risk Premia
43 Pages Posted: 21 Jun 2021 Last revised: 29 Jan 2023
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Option-Implied Spreads and Option Risk Premia
Option-Implied Spreads and Option Risk Premia
Date Written: June 2021
Abstract
We propose implied spreads (IS) and normalized implied spreads (NIS) as simple measures to characterize option prices. IS is the credit spread of an option’s implied bond, the portfolio long a risk-free bond and short a put option. NIS normalizes IS by the risk-neutral default probability and reflects tail risk. IS and NIS are countercyclical and predict implied bond returns, while neither, like implied volatility, predicts put returns. These opposite predictability results are consistent with a stochastic volatility, stochastic jump intensity model, as put premia increase in volatility but decrease in jump intensity, while implied bond premia increase in both.
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