Stock Return Autocorrelations and Expected Option Returns

Yoontae Jeon (), Raymond Kan () and Gang Li ()
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Yoontae Jeon: DeGroote School of Business, McMaster University, Hamilton, Ontario L8S 4L8, Canada
Raymond Kan: Rotman School of Management, University of Toronto, Toronto, Ontario M5S 3E6, Canada
Gang Li: CUHK Business School, The Chinese University of Hong Kong, Hong Kong

Management Science, 2025, vol. 71, issue 6, 4895-4914

Abstract: We show that the return autocorrelation of underlying stock is an important determinant of expected equity option returns. Using an extended Black-Scholes model incorporating the presence of stock return autocorrelation, we demonstrate that expected returns of both call and put options are increasing in the return autocorrelation coefficient of the underlying stock. Consistent with this insight, we find strong empirical support in the cross-section of average returns of equity options. Our paper highlights the necessity to control for stock return autocorrelation when studying option return predictability.

Keywords: stock return autocorrelation; expected option returns; cross-section of option returns; option portfolios (search for similar items in EconPapers)
Date: 2025
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