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The Factor Structure in Equity Options

Peter Christoffersen¹; Mathieu Fournier²; Kris Jacobs³

¹ University of Toronto, Copenhagen Business School, and CREATES · ² HEC Montréal · ³ University of Houston

Equity options display a strong factor structure. The first principal components of the equity volatility levels, skews, and term structures explain a substantial fraction of the cross-sectional variation. Furthermore, these principal components are highly correlated with the S&P 500 index option volatility, skew, and term structure, respectively. We develop an equity option valuation model that captures this factor structure. The model predicts that firms with higher market betas have higher implied volatilities, steeper moneyness slopes, and a term structure that covaries more with the market. The model provides a good fit, and the equity option data support the model’s cross-sectional implications. Received December 20, 2013; editorial decision April 15, 2017 by Editor Leonid Kogan.

DOI

10.1093/rfs/hhx089

Volume

31 (2)

Pages

595-637

Language

en

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