Option Volatility Spread Factor Predicts Option Returns
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Uncertainty of Put-Call Parity Violation and Option Returns
Chun Liu; Tianyu Wang; Yintian Wang; Hong Xiang
- Tsinghua University
- CAUniversity of Toronto
- ?Tsinghua University - School of Economics and Management
- ?Tsinghua University, School of Economics and Management
- HKHong Kong Polytechnic University
- ?The Hong Kong Polytechnic University
Strategy in a nutshell
Invest in U.S. equity options by sorting on volatility-of-volatility spread (VVS), going long low-VVS and short high-VVS options. Portfolio is equally weighted and rebalanced monthly.
Economic rationale
VVS captures option mispricing due to hedging costs, informed trading, short-sale constraints, and illiquidity. Exploiting VVS allows more precise prediction of option returns than using volatility spread alone.
Backtest performance
Annualised return12.82%
Volatility6.78%
Sharpe ratio1.89
Win rate71%