Publication

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

Accepted at the Journal of Finance


This paper investigates the performance of option investments across different stocks by computing monthly returns on at-the-money straddles on individual equities. It finds that options with high historical returns continue to significantly outperform options with low historical returns over horizons ranging from 6 to 36 months. This phenomenon is robust to including out-of-the-money options or delta-hedging the returns. Unlike stock momentum, option return continuation is not followed by long-run reversal. Significant returns remain after factor risk adjustment and after controlling for implied volatility and other characteristics. Across stocks, trading costs are unrelated to the magnitude of momentum profits.

Working Papers:

Hedge Fund Option Usage and Skewness Risk Premium, with Shuaiyu Chen 


We study how hedge fund option usage can affect the skewness risk premium in the cross-section of individual stock options. We find that stocks with more of their hedge fund holders employing the long naked put strategy (long put option without the underlying stock) have more positive returns of their skewness assets comprised of options, whose payoff (price) resembles the realized (risk-neutral) skewness of the underlying stock return. We document evidence consistent with a price-pressure channel: Those stocks face larger demand on their out-of-the-money put options, which makes their risk-neutral skewness more negative and lowers the price of skewness asset; In the meanwhile, the long naked put positions of hedge funds cannot predict the realized skewness. The channel works through the idiosyncratic rather than systematic component of skewness. Other hedge fund option strategies cannot robustly predict skewness asset returns. 

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

R&R at RFS


This paper proposes a new approach for implementing “equity VIX portfolios” in settings where the number of traded options is limited. The resulting values are the prices of portfolios designed to best replicate the payoffs of variance swaps, and they are also interpretable as implied variances. We show that our approach outperforms other methods, such as the CBOE's own VIX formula, both in artificial and actual data. Using these portfolios, we document seasonal momentum in option returns, the tendency of stocks whose options performed well at periodic lags to continue their good performance in the future. A long-short portfolio based on seasonal momentum achieves a pre-cost Sharpe ratio of 3.31 annualized.


Mutual Fund Hedging Demand and Individual Equity Option Returns


I hypothesize that mutual fund ownership concentration, measured as the Herfindahl-Hirschman Index (HHI), in the underlying stock is positively correlated with stock holders' hedging demand for options on the  corresponding stock. As for the stock with more concentrated ownership, some funds are more likely to overweight it and demand more of its options to hedge. Under the demand-based option pricing framework, market makers would charge higher option prices to absorb the order imbalance, which leads to lower subsequent option returns. Consistent with the demand-pressure channel, I find that HHI negatively predicts cross-sectional delta-hedged option returns: First, the predictability is driven by the funds that use protective put strategy to hedge the downside risk; Second, it is stronger among options with higher unhedgeable risks; Third, the effect takes places on puts rather than calls; Fourth, HHI cannot predict the underlying stock returns; Lastly, transaction data reveals that professional investors' demand is larger for puts written on the stocks with higher HHI. The findings cannot be reconciled with alternative explanations including short-selling costs and belief dispersions.