The Puzzle of Index Option Returns


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CONSTANTINIDES, George M., Jens Carsten JACKWERTH, Alexi SAVOV, 2011. The Puzzle of Index Option Returns

@techreport{Constantinides2011Puzzl-29708, series={Working Paper Series / Department of Economics}, title={The Puzzle of Index Option Returns}, year={2011}, number={2011-17}, author={Constantinides, George M. and Jackwerth, Jens Carsten and Savov, Alexi} }

The Puzzle of Index Option Returns Savov, Alexi Jackwerth, Jens Carsten 2015-02-02T12:40:41Z Jackwerth, Jens Carsten Constantinides, George M. 2011 eng Constantinides, George M. Savov, Alexi 2015-02-02T12:40:41Z We document that the leverage-adjusted returns on S&P 500 index call and put portfolios are decreasing in their strike-to-price ratio over 1986-2009, contrary to the prediction of the Black-Scholes-Merton model. We test a large number of plausible factor models in order to learn what drives the violations of the Black-Scholes-Merton model. Consistent with the picture that crisis-related factors operate across the equities and index options markets, factors which capture jumps in market volatility, jumps in the market index, and changes in liquidity work reasonably well in explaining the cross-section of index option returns, even when we impose the restriction that the premia are estimated from the universe of equities. Furthermore, the factor that captures jumps in market volatility also reduces the pricing errors of the 25 Fama-French portfolios by more than Size and only a bit less than Value.

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