Expected Option Returns
Read the paperopens doi.org in a new tab
What they found
The authors asked a simple question: what returns do options actually earn when held to expiration? Using S&P 500 and S&P 100 index options from 1986 to 1995, they found that call returns were positive but lower than the leverage would imply, and put returns were dramatically negative (buying puts lost around 10% per week). Most striking, zero-beta straddles, which should earn the risk-free rate if only market risk is priced, lost about 3% per week, meaning that being long volatility is systematically expensive and volatility risk carries its own negative premium.
What you can use
- Buying index puts has been one of the most reliably losing trades in finance: they are insurance, and insurance costs money.
- Being long volatility through straddles loses money on average; sellers of volatility collect a premium for bearing crash risk.
- The premium is compensation for real risk: volatility sellers get hit hard in crashes, and the average masks that.
Caveats
1986 to 1995 sample including the 1987 crash; returns are gross of the wide bid-ask spreads in options. Index options only; single-stock option returns differ.
Tags: options, option-returns, variance-risk-premium, puts
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.