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Expected Option Returns

Authors

  • Joshua D. Coval,

  • Tyler Shumway

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    • Both authors are from the University of Michigan Business School, Ann Arbor, Michigan. We thank Sugato Bhattacharya, Jonathan. Paul Carmel, Artyom Durnev, Nejat Seyhun, René Stulz, an anonymous referee, and seminar participants at the University of Michigan, Michigan State University, Ohio State University, the University of Texas at Austin, and Washington University in Saint Louis for useful comments. We also thank the University of Michigan Business School for purchasing the data used in this study. Remaining errors are, of course, our responsibility.

ABSTRACT

This paper examines expected option returns in the context of mainstream asset-pricing theory. Under mild assumptions, expected call returns exceed those of the underlying security and increase with the strike price. Likewise, expected put returns are below the risk-free rate and increase with the strike price. S&P index option returns consistently exhibit these characteristics. Under stronger assumptions, expected option returns vary linearly with option betas. However, zero-beta, at-the-money straddle positions produce average losses of approximately three percent per week. This suggests that some additional factor, such as systematic stochastic volatility, is priced in option returns.

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