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Determinants of S&P 500 index option returns

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Abstract

We analyze common factors that affect returns on S&P 500 index options and find that 93% of the variation in option returns can be explained by three factors, which respectively account for 87%, 4%, and 2% of the variation in option returns. Furthermore, we test diffusion option pricing models by using mean–variance spanning properties implied in the models. The spanning tests reject one-factor diffusion models, as well as the hypothesis that the underlying asset and an equally weighted option index span options. Our results fail to reject that the underlying asset and an at-the-money option can span out-of-the-money options, but does reject that they span in-the-money options.

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Authors and Affiliations

  1. Smeal College of Business, Pennsylvania State University, University Park, PA, 16802, USA

    Charles Cao & Jing-Zhi Huang

  2. China Center for Financial Research, Beijing, China

    Charles Cao

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  1. Charles Cao
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  2. Jing-Zhi Huang
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Correspondence to Charles Cao.

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Cao, C., Huang, JZ. Determinants of S&P 500 index option returns. Rev Deriv Res 10, 1–38 (2007). https://doi.org/10.1007/s11147-007-9015-5

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