[This study demonstrates the impact of systematic risk on the prices of individual equity options. The option prices are characterized by the level and slope of implied volatility curves, and the systematic risk is measured as the proportion of systematic variance in the total variance. Using daily option quotes on the S&P 100 index and its 30 largest component stocks, we show that after controlling for the underlying asset's total risk, a higher amount of systematic risk leads to a higher level of implied volatility and a steeper slope of the implied volatility curve. Thus, systematic risk proportion can help differentiate the price structure across individual equity options.]

We empirically examine the impact of trading activities on the liquidity of individual equity options measured by the proportional bid–ask spread. There are three main findings. First, the option return volatility, defined as the option price elasticity times the stock return volatility, has a much higher power in explaining the spread variations than the commonly considered liquidity determinants such as the stock return volatility and option trading volume. Second, after controlling for all the liquidity determinants, we find a maturity-substitution effect due to expiration cycles. When medium-term options (60–90days maturity) are not available, traders use short-term options as substitutes whose higher volume leads to a smaller bid–ask spread or better liquidity. Third, we also find a moneyness-substitution effect induced by the stock return volatility. When the stock return volatility goes up, trading shifts from in-the-money options to out-of-the-money options, causing the latter’s spread to narrow.

This study investigates whether stock market returns are related to temperature. Research in psychology has shown that temperature significantly affects mood, and mood changes in turn cause behavioral changes. Evidence suggests that lower temperature can lead to aggression, while higher temperature can lead to both apathy and aggression. Aggression could result in more risk-taking while apathy could impede risk-taking. We therefore expect lower temperature to be related to higher stock returns and higher temperature to be related to higher or lower stock returns, depending on the trade-off between the two competing effects. We examine many stock markets world-wide and find a statistically significant, negative correlation between temperature and returns across the whole range of temperature. Apathy dominates aggression when temperature is high. The observed negative correlation is robust to alternative tests and retains its statistical significance after controlling for various known anomalies.

This study demonstrates the impact of systematic risk on the prices of individual equity options. The option prices are characterized by the level and slope of implied volatility curves, and the systematic risk is measured as the proportion of systematic variance in the total variance. Using daily option quotes on the S, and P 100 index and its 30 largest component stocks, we show that after controlling for the underlying asset's total risk, a higher amount of systematic risk leads to a higher level of implied volatility and a steeper slope of the implied volatility curve. Thus, systematic risk proportion can help differentiate the price structure across individual equity options.

We establish the existence of liquidity risk premium in option returns via sorting analyses and Fama-MacBeth regressions. In leverage-adjusted, hedged returns, the alpha due to liquidity risk ranges from 8.5 to 14.6 basis points per month. In hedged returns unadjusted for leverage, the alpha ranges from 165.9 to 185.1 basis points per month. Compared with the option bid-ask spread, the premium is small in magnitude. In contrast to the findings for stocks and bonds, the liquidity risk premium uncovered in option returns is negative. We explain the negative premium by noting that option end-users write options in net and they might care more about liquidity risk than market makers.

This paper investigates the motive of option trading. We show that option trading is mostly driven by differences of opinion, a finding different from the current literature that attempts to attribute option trading to information asymmetry. Our conclusion is based on three pieces of empirical evidence. First, option trading around earnings announcements is speculative in nature and mostly dominated by small, retail investors. Second, around earnings announcements, the pre-announcement abnormal turnovers of options seem to predict the post-announcement abnormal stock returns. However, once we control for the pre-announcement stock returns, the predictability completely disappears, implying that option traders simply take cues from the stock market and turn around to speculate in the options market. Third, cross-section and time-series regressions reveal that option trading is also significantly explained by differences of opinion. While informed trading is present in stocks, it is not detected in options.

Existing research on executive stock options mainly focuses on total risk when studying risk incentives. In this study, we use a GARCH option pricing framework to show that the incentive effects of executive stock options depend on the composition of risk. Controlling for total risk, the value of executive stock options increases with systematic risk and this effect is stronger when the total risk is low. Thus, when firms grant standard or non-indexed options, CEOs will have incentives to increase systematic risk even when the total risk remains constant. In contrast, indexed options will provide CEOs with incentives to reduce systematic risk. We therefore conclude that an optimal mix of indexed and non-indexed option grants will provide CEOs with incentives to take the desired level of systematic risk.

ABSTRACT We find that liquidity is priced in corporate yield spreads. Using a battery of liquidity measures covering over 4,000 corporate bonds and spanning both investment grade and speculative categories, we find that more illiquid bonds earn higher yield spreads, and an improvement in liquidity causes a significant reduction in yield spreads. These results hold after controlling for common bond‐specific, firm‐specific, and macroeconomic variables, and are robust to issuers' fixed effect and potential endogeneity bias. Our findings justify the concern in the default risk literature that neither the level nor the dynamic of yield spreads can be fully explained by default risk determinants.