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

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  • Borochin, Paul
  • Wu, Zekun
  • Zhao, Yanhui

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.

Suggested Citation

  • Borochin, Paul & Wu, Zekun & Zhao, Yanhui, 2021. "The effect of option-implied skewness on delta- and vega-hedged option returns," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 74(C).
    • Handle: RePEc:eee:intfin:v:74:y:2021:i:c:s1042443121001244
    DOI: 10.1016/j.intfin.2021.101408
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    More about this item

    Keywords

    Risk neutral skewness; Options; Return predictability;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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