Common Factors in Equity Option Returns

Alex Horenstein, Aurelio Vasquez and Xiao Xiao

The Review of Financial Studies, 2026, vol. 39, issue 3, 835-874

Abstract: We explore the factor structure in delta-hedged equity option returns. A sparse latent factor model generates a correlation of 0.90 or higher between average and predicted option returns. A comparable performance is achieved with a characteristic-based model containing four factors: the equally weighted option portfolio, a factor based on the difference between historical and implied volatilities, a factor based on the ratio of corporate cash holdings to the total value of the firm’s assets, and a factor based on volatility of volatility. Traditional stock return factors cannot explain these option factors.

Keywords: C14; G13; G17 (search for similar items in EconPapers)
Date: 2026
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