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Common Factors in Equity Option Returns

Author

Listed:
  • Alex Horenstein
  • Aurelio Vasquez
  • Xiao Xiao

Abstract

We explore the factor structure in delta-hedged equity option returns. A sparse latent factor model generates a correlation of 0.90 or higher between average and predicted option returns. A comparable performance is achieved with a characteristic-based model containing four factors: the equally weighted option portfolio, a factor based on the difference between historical and implied volatilities, a factor based on the ratio of corporate cash holdings to the total value of the firm’s assets, and a factor based on volatility of volatility. Traditional stock return factors cannot explain these option factors.

Suggested Citation

  • Alex Horenstein & Aurelio Vasquez & Xiao Xiao, 2026. "Common Factors in Equity Option Returns," The Review of Financial Studies, Society for Financial Studies, vol. 39(3), pages 835-874.
    • Handle: RePEc:oup:rfinst:v:39:y:2026:i:3:p:835-874.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhaf060
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    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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