Swing Trading Signals


Since 2013

  • 100% Quantified, data-driven and Backtested
  • We always show our results!
  • Signals every day via our site or email
  • Cancel at any time!

Equity Volatility Term Structures and the Cross-Section of Option Returns

Last Updated on 10 February, 2024 by Rejaul Karim

In the pursuit of unraveling the intricacies of option returns, Aurelio Vasquez explores a compelling dimension in “Equity Volatility Term Structures and the Cross-Section of Option Returns.” The study delves into the relationship between the implied volatility term structure’s slope and subsequent option returns.

By categorizing firms based on this slope, the research scrutinizes the performance of straddle portfolios. Strikingly, portfolios with elevated slopes in the volatility term structure exhibit a noteworthy outperformance compared to their counterparts with lower slopes.

This disparity proves both economically and statistically significant, resisting explanation through traditional factors, higher-order option variables, or jump risk. Vasquez’s investigation unveils a nuanced interplay between volatility term structures and the cross-section of option returns, adding a distinctive layer to our understanding of equity dynamics.

Abstract Of Paper

The slope of the implied volatility term structure is positively related to future option returns. We rank firms based on the slope of the volatility term structure and analyze the returns for straddle portfolios. Straddle portfolios with high slopes of the volatility term structure outperform straddle portfolios with low slopes by an economically and statistically significant amount. The results are robust to different empirical setups and are not explained by traditional factors, higher-order option factors, or jump risk.

Original paper – Download PDF

Here you can download the PDF and original paper of Equity Volatility Term Structures and the Cross-Section of Option Returns.

(An option to download will come shortly)

Author

Aurelio Vasquez
Instituto Tecnológico Autónomo de México (ITAM) – Department of Business Administration

Conclusion

In summary, the examination of equity volatility term structures unveils a compelling relationship with the cross-section of option returns. Focusing on the positive association between the implied volatility term structure’s slope and future option returns, firms are effectively ranked based on this slope.

The subsequent analysis of straddle portfolios reveals a noteworthy outperformance of portfolios with high volatility term structure slopes compared to those with low slopes. Importantly, this outperformance stands out both economically and statistically, remaining robust across various empirical setups.

Furthermore, it is noteworthy that these results persist independently of traditional factors, higher-order option factors, or jump risk, underscoring the unique and valuable insights provided by the implied volatility term structure in predicting option returns.

Related Reading:

Slow Trading and Stock Return Predictability

Has Goodwill Accounting Gone Bad?

FAQ

1. What is the primary focus of the study “Equity Volatility Term Structures and the Cross-Section of Option Returns”?

The study focuses on exploring the relationship between the slope of the implied volatility term structure and subsequent option returns. It categorizes firms based on this slope and examines the performance of straddle portfolios to understand the impact on option returns.

2. How does the implied volatility term structure impact straddle portfolios in the study?

The study finds that straddle portfolios with high slopes in the implied volatility term structure outperform portfolios with low slopes. This outperformance is both economically and statistically significant, indicating a positive association between the slope of the volatility term structure and future option returns.

3. Are the results robust, and do they withstand explanations from traditional factors or additional risk variables?

Yes, the results are robust across various empirical setups. Importantly, the outperformance of straddle portfolios with high volatility term structure slopes is not explained by traditional factors, higher-order option factors, or jump risk. This emphasizes the unique predictive power of the implied volatility term structure in understanding and forecasting option returns.

Find A Comprehensive Database of Research Papers On Trading Strategies here

{"email":"Email address invalid","url":"Website address invalid","required":"Required field missing"}

Monthly Trading Strategy Club

$42 Per Strategy

>

Login to Your Account



Signup Here
Lost Password