Publication

The Variance Premium and Seasonal Momentum in Option Returns, with Steven Heston, Christopher Jones, Mehdi Khorram, and Haitao Mo

Forthcoming at the Review of Financial Studies

Option Momentum, 2023, with Steven Heston, Christopher Jones, Mehdi Khorram, and Haitao Mo

Journal of Finance, Volume 78, Issue 6, Pages 3141-3192

This paper combines two working papers ``Option Momentum'' by Heston and Li, and ``Momentum, Reversal, and Seasonality in Option Returns'' by Jones, Khorram, and Mo.
Link to the working paper version [SSRN]

Working Papers:

CICF 2026, MFA 2026*, 2025 FMA Conference on Derivatives and Volatility, 2025 New Zealand Finance Meeting

How do investors perceive the risks on individual stocks, and why do these beliefs matter? We recover analysts’ expectations of returns, variance, and skewness from bull, base, and bear forecasts in more than 180,000 reports from ten major brokerages. These expectations predict future volatility and asymmetry and support option strategies with Sharpe ratios near one. Consistent with asset-pricing theory, expected returns increase with perceived variance and decrease with perceived upside skewness. Greater disagreement about variance accompanies higher future volatility and more expensive volatility protection. Scenario narratives help explain these higher-moment beliefs, with distinct information shaping variance and skewness. Applying machine-learning models trained on scenario narratives to 30 additional brokers’ reports produces text-based expectations that also predict future volatility, skewness, and option returns, extending the measurement of higher-moment beliefs beyond explicit price scenarios.

(Supersede an earlier version with Lihai Yang)

(Semifinalist for 2026 FMA Best Paper Award in Options & Derivatives)

CDI 2026, FMA 2026

We find strong evidence of peer momentum in delta-hedged option returns. Our main peer momentum measure, in which firms are linked if they share common sell-side analysts, is highly profitable, with a pre-cost Sharpe ratio of 3. It is distinct from standard momentum, and there is little impact from controlling for standard momentum or other well-know option return predictors. It is robust to the length of the formation periods, the method of return computation, and realistic assumptions about transactions costs. Alternative methods for linking peer firms usually result in weaker performance, though it in most cases remains highly significant. We show that peer momentum is consistent with underreaction of implied volatilities to volatility shocks of peer firms. Using several different approaches, we also show that factor momentum only partially explains peer momentum, and vice versa. Our final results demonstrate the new finding of peer reversal, which is present in a smaller number of firm pairs but is nevertheless highly significant.

R&R at the Journal of Financial and Quantitative Analysis

(2024 FMA Best Paper Award in Options & Derivatives)

We examine how the option demand of various financial institutions affects the crash risk premium in individual stock options. We find that only hedge funds’ speculative demand has a significant impact. Their demand for put options increases the premium for crash insurance. This effect is concentrated in options with high hedging costs and stems from hedge funds’ long naked put positions. We provide evidence that hedge funds purchase out-of-the-money puts to speculate on the intermediate, not the extreme, left tails of individual firms. They use these options to amplify underlying stock price movements and pay a premium for the leverage.