Option Returns and Volatility Mispricing

38 Pages Posted: 14 Mar 2006

See all articles by Amit Goyal

Amit Goyal

University of Lausanne; Swiss Finance Institute

Alessio Saretto

Federal Reserve Banks - Federal Reserve Bank of Dallas

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 )

Batiment Extranef 226
Lausanne, Vaud CH-1015
Switzerland
+41 21 692 3676 (Phone)
+41 21 692 3435 (Fax)

HOME PAGE: http://www.hec.unil.ch/agoyal/

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Alessio Saretto (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

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