We find a negative relation between firm-level political risk and future delta-hedged equity option returns. A quasi-natural experiment based on Brexit corroborates this finding since after the referendum there is a decrease in the option returns of the positive-Brexit exposure firms. The predictability is driven by the jump risk component of political uncertainty, is more pronounced in periods of high intermediary constraints, and is stronger among high-demand pressure options but weaker among politically active firms. Finally, consistent with a risk-based explanation, investors of options on politically risky firms are compensated with high returns when major unexpected political shocks happen.

We use a simple two-stage dividend growth model to connect profitability growth and firm scale to stock returns. In this framework, both the magnitude and the length of the first-stage growth play a key role in determining returns. Using current profitability growth to estimate magnitude and firm scale as inverse proxy for length, we predict that future returns should increase with current profitability growth but, crucially, the effect should diminish with firm scale. Across a range of empirical tests, we find strong evidence in support of our model determinants and predictions. Our findings are not explained by an array of associated, potentially confounding variables.