The effect of option-implied skewness on delta- and vega-hedged option returns

Paul Borochin, Zekun Wu and Yanhui Zhao

Journal of International Financial Markets, Institutions and Money, 2021, vol. 74, issue C

Abstract: We study the relation between option-implied skewness (IS) and the cross-section of option returns under daily hedging to better understand the pricing of skewness in isolation from lower moments. Creating portfolios of delta-hedged (D-hedged) and delta-vega-hedged (DV-hedged) options with daily rebalancing, we find that IS is negatively related to both D-hedged and DV-hedged call option returns, but has no significant relation to hedged put option returns. The negative relation observed is stronger when the underlying stock has a larger market beta and when the firm is more opaque. Our results suggest that investors’ skewness preference grows stronger with greater market risk and lower information quality.

Keywords: Risk neutral skewness; Options; Return predictability (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfin:v:74:y:2021:i:c:s1042443121001244

DOI: 10.1016/j.intfin.2021.101408

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