Last Updated on 10 February, 2024 by Rejaul Karim
Exploring the thematic underpinnings of market timing, the research paper “The Timing of Option Returns” by Adriano Tosi of Wellington Management and Alexandre Ziegler of the University of Zurich offers a pioneering empirical elucidation, underscoring the concentrated returns derived from shorting out-of-the-money S&P 500 put options in the days anteceding their expiration.
Revelatory findings illustrate that back-month options yield minimal returns, while front-month options efficaciously generate returns solely towards the fag end of the option cycle.
Emphatically, the study unravels the option premium’s quintessence, ostensibly converging towards the option cycle’s culmination, attributed to transformative shifts in the options’ risk attributes. Remarkably, the amplified convexity risk proximate to maturity heightens the options’ sensitivity to underlying price jumps, while the volatility risk diminishes in significance.
This incisive analysis furnishes a conduit for speculative practitioners to capitalize on the put option premium by shorting front-month options exclusively in the waning days of the cycle, while furnishing a strategic proclivity for investors to abate hedging costs through back-month options.
Abstract Of Paper
We document empirically that the returns from shorting out-of-the-money S&P 500 put options are concentrated in the few days preceding their expiration. Back-month options generate almost no returns, and front-month options do so only towards the end of the option cycle. The concentration of the option premium at the end of the cycle reflects changes in options’ risk characteristics. Specifically, options’ convexity risk increases sharply close to maturity, making them more sensitive to jumps in the underlying price. By contrast, volatility risk plays a smaller role close to maturity. Our results imply that speculators wishing to harvest the put option premium should short front-month options only during the last days of the cycle, while investors wishing to protect against downside risk should use back-month options to reduce hedging costs.
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University of Zurich – Department of Banking and Finance
In summation, the research paper “The Timing of Option Returns” authored by Adriano Tosi and Alexandre Ziegler propels a paradigm-shifting exegesis into the art of market timing through a trenchant focus on option returns.
Astutely unearthing the preponderant concentration of returns stemming from shorting out-of-the-money S&P 500 put options in the precipice of their expiration, the research delineates the dearth of returns from back-month options, with front-month options materializing returns solely towards the denouement of the option cycle.
Paramount to these revelations is the discernment of the option premium’s effusion, tactically gravitating towards the cycle’s termination, accentuated by the metamorphosis in options’ risk dynamics.
Emanating from this discernment, the study proffers a strategic playbook, enjoining speculative protagonists to harness the put option premium by shorting front-month options specifically in the twilight of the cycle, alongside conferring a judicious recourse for investors to mitigate hedging costs through back-month options.
In essence, this seminal study augurs the unveiling of an indelible lexicon predisposing an avant-garde outlook towards market timing expounded through the prism of option returns, fostering a transformative landscape of investment praxis that challenges erstwhile conventions with lucid findings and astute stratagems.
Q1: What is the focus of the research paper “The Timing of Option Returns”?
A1: The research paper “The Timing of Option Returns” explores the empirical aspects of market timing, particularly concentrating on the returns generated from shorting out-of-the-money S&P 500 put options. The study highlights the concentration of returns in the days leading up to the expiration of these options.
Q2: According to the findings, where are the returns concentrated when shorting out-of-the-money S&P 500 put options?
A2: The returns from shorting out-of-the-money S&P 500 put options are concentrated in the few days preceding their expiration, according to the research.
Q3: What is the reason behind the concentration of the option premium towards the end of the option cycle, according to the research?
A3: The concentration of the option premium towards the end of the cycle is attributed to changes in the risk characteristics of options. Specifically, the study notes that options’ convexity risk increases sharply close to maturity, making them more sensitive to jumps in the underlying price. Volatility risk plays a smaller role close to maturity.