Common Factors in Equity Option Returns

Alex R. Horenstein; Aurelio Vasquez; Xiao Xiao

doi:10.1093/rfs/hhaf060

Common Factors in Equity Option Returns

Alex R. Horenstein¹; Aurelio Vasquez²; Xiao Xiao³

¹ Miami Herbert Business School , · ² Business School, ITAM , · ³ Cambridge Judge Business School, University of Cambridge ,

Review of Financial Studies 2026

We explore the factor structure in delta-hedged equity option returns. A sparse latent factor model generates a correlation of 0.90 or higher between average and predicted option returns. A comparable performance is achieved with a characteristic-based model containing four factors: the equally weighted option portfolio, a factor based on the difference between historical and implied volatilities, a factor based on the ratio of corporate cash holdings to the total value of the firm’s assets, and a factor based on volatility of volatility. Traditional stock return factors cannot explain these option factors.

DOI: 10.1093/rfs/hhaf060
Volume: 39 (3)
Pages: 835-874
Language: en
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