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A Nonlinear Factor Analysis of S&P 500 Index Option Returns



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    • Christopher S. Jones is at University of Southern California. I am grateful to Doron Avramov, Luca Benzoni, Josh Coval, Rick Green, Eric Ghysels, John Griffin, Larry Harris, John Long, Spencer Martin, Bruce Mizrach, Allen Poteshman, Robert Stambaugh, Robert Tompkins, Harold Zhang, an anonymous referee and associate editor, and seminar participants at Arizona State University, the University of Rochester, the University of Southern California, the University of North Carolina, the 2001 European Finance Association summer meetings, the 2002 American Finance Association meetings, and the 2004 meetings of the Society for Nonlinear Dynamics and Econometrics for many useful comments. All errors are my own.


Growing evidence suggests that extraordinary average returns may be obtained by trading equity index options, and that at least part of this abnormal performance is attributable to volatility and jump risk premia. This paper asks whether such priced risk factors are alone sufficient to explain these average returns. To provide an answer in as general as possible a setting, I estimate a flexible class of nonlinear models using all S&P 500 Index futures options traded between 1986 and 2000. The results show that priced factors contribute to these expected returns but are insufficient to explain their magnitudes, particularly for short-term out-of-the-money puts.