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The Term Structure of Credit Default Swap Spreads and the Cross Section of Options Returns

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  • Hao Zhang
  • Yukun Shi
  • Dun Han
  • Pei Liu
  • Yaofei Xu

Abstract

This paper, using the natural logarithmic form credit default swap (log CDS) slope, examines the variation in cross‐sectional 1‐month ATM delta‐hedged straddle returns. Our analysis reveals that the log CDS slope significantly and positively predicts these returns, even when accounting for several key volatility mispricing factors. Further investigation shows that this predictive relationship exhibits a strong time‐varying pattern, closely linked to market conditions. In contrast, the relationship between notable volatility mispricing factors and straddle returns remains relatively stable over time. Constructing a long‐short quintile portfolio on straddle options confirms that trading performance improves when the past 12‐month market return is at a historically lower level, market volatility is at a historically higher level, and the VIX is elevated. Log CDS slope, as a proxy for excess jump risk premium, significantly predicts delta‐hedged option returns during periods of high volatility.

Suggested Citation

  • Hao Zhang & Yukun Shi & Dun Han & Pei Liu & Yaofei Xu, 2025. "The Term Structure of Credit Default Swap Spreads and the Cross Section of Options Returns," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 45(6), pages 637-658, June.
    • Handle: RePEc:wly:jfutmk:v:45:y:2025:i:6:p:637-658
    DOI: 10.1002/fut.22582
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    References listed on IDEAS

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