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The Joint Cross Section of Stocks and Options
Stocks with large increases in call (put) implied volatilities over the previous month tend to have high (low) future returns. Sorting stocks ranked into decile portfolios by past call implied volatilities produces spreads in average returns of approximately 1% per month, and the return differences persist up to six months. The cross section of stock returns also predicts option implied volatilities, with stocks with high past returns tending to have call and put option contracts that exhibit increases in implied volatility over the next month, but with decreasing realized volatility. These predictability patterns are consistent with rational models of informed trading.
Journal Article
Options for volatile markets : managing volatility and protecting against catastrophic risk
\"Traditional thinking about investment has been thrown on its head in the wake of the financial crisis. Many investors no longer accept the idea that diversification reduces risk and the stock market provides the best long-term returns. With global markets increasingly interlinked, markets tend to move in concert, reducing the benefits of diversification. And given the gravity of today's economic problems, many question whether the stock market will soon continue its inexorable march higher. In Options in Volatile Markets, Lehman and McMillan provide investors with strategies to generate double-digit returns and to protect against market crashes. The new edition discusses the changing investment environment; explains how to use options with ETFs; and shows how build \"catastrophic\" protection into a portfolio. While the core strategy remains covered call writing - selling a call option on a stock the investor already owns - the authors discuss other strategies to capitalize on high-flying stocks. Most importantly, for investors looking for high returns but fearful that the market might crash, the authors discuss low-cost options strategies that effectively provide insurance for a portfolio\"-- Provided by publisher.
Book
Performance Feedback and Firm Risk Taking: The Moderating Effects of CEO and Outside Director Stock Options
We contribute to the behavioral theory of the firm and the behavioral agency model by developing a theoretical framework that predicts the differential interaction effects of performance feedback and values of stock option grants of multiple agents on firm risk taking. We explain how chief executive officers (CEOs) versus outside directors awarded with stock option grants perceive negative or positive deviations from prior performance. We argue that in a negative attainment discrepancy context, high values of option grants will increase the risk aversion of CEOs who already bear excessive employment and compensation risks, resulting in less risk taking; however, it will enhance the risk-taking propensity of influential outside directors who increase monitoring and support for risky projects because their risk preferences are better aligned with those of shareholders. In a positive attainment discrepancy context, high values of option grants will amplify risk aversion in both CEOs and outside directors who perceive risky strategies as potential threats to anticipated incentive values associated with a gain domain, thereby reducing risk-taking activities. Analysis of panel data from 1992 to 2006 on the research and development spending of U.S. manufacturing firms based on Arellano–Bond dynamic panel regression reveals findings largely consistent with our predictions.
Journal Article
How Misconduct Spreads
I study the role of external auditors in the diffusion of stock-option backdating in the U.S. to explore the role of professional experts in the diffusion of innovative practices that subvert stakeholders’ interests. Practices that are eventually accepted as misconduct may emerge as liminal practices—ethically and legally questionable but not clearly illegitimate or outlawed—and not be categorized as misconduct until social control agents notice, scrutinize, and react to them. I examine how the role of external auditors in the diffusion of stock-option backdating changed as the practice shifted from liminality to being illegal and illegitimate. The findings suggest that professional experts’ involvement in the diffusion of liminal practices is highly responsive to the institutional environment. Initially, professional experts diffuse these practices via local networks, but when the legal environment becomes more stringent, implying that the practice will become illegitimate, experts reverse their role and extinguish the practice. The larger network remains largely uninvolved in both diffusing and extinguishing the liminal practice until the practice is publicly exposed and labeled as illegal and illegitimate. The findings further show that the diffusion and then extinguishing of backdating before it was outlawed depended on the adopter’s geographic proximity to a local office of a complacent expert and on the absence of traceable communication about backdating between these offices. This combination set the stage for each office to develop independent views about backdating, leading some offices to view backdating favorably and diffuse it, and others to view it unfavorably and curtail it—even at the same time and within the same audit firm. This study contributes to research on the diffusion of misconduct by providing insight into the role of professional experts and the mechanisms and boundary conditions governing that role.
Journal Article
Trading options Greeks : how time, volatility, and other pricing factors drive profits
\"A top options trader details a practical approach for pricing and trading options in any market conditionThe options market is always changing, and in order to keep up with it you need the greeks--delta, gamma, theta, vega, and rho--which are the best techniques for valuing options and executing trades regardless of market conditions. In the Second Edition of Trading Options Greeks, veteran options trader Dan Pasarelli puts these tools in perspective by offering fresh insights on option trading and valuation.An essential guide for both professional and aspiring traders, this book explains the greeks in a straightforward and accessible style. It skillfully shows how they can be used to facilitate trading strategies that seek to profit from volatility, time decay, or changes in interest rates. Along the way, it makes use of new charts and examples, and discusses how the proper application of the greeks can lead to more accurate pricing and trading as well as alert you to a range of other opportunities. Completely updated with new material Information on spreads, put-call parity and synthetic options, trading volatility, and advanced option trading is also included Explores how to exploit the dynamics of option pricing to improve your trading Having a comprehensive understanding of the greeks is essential to long-term options trading success. Trading Options Greeks, Second Edition shows you how to use the greeks to find better trades, effectively manage them, and ultimately, become more profitable\"-- Provided by publisher.
Book
Optimal contracting under mean-volatility joint ambiguity uncertainties
We examine a continuous-time principal-agent problem under mean-volatility joint ambiguity uncertainties. Both the principal and the agent exhibit Gilboa–Schmeidler’s extreme ambiguity aversion with exponential utilities. We distinguish between expost realized and exante perceived volatilities, and argue that the second-best contract necessarily consists of two sharing rules: one for realized outcome and the other for realized volatility. The outcome-sharing rule is for uncertainty sharing and work incentives, as usual, and the volatility-sharing rule is to align the agent’s worst prior with that of the principal. At optimum, their worst priors are symmetrized, and realized compensation is positively related to realized volatility. This theoretical positive relation can be consistent with popular managerial compensation practices such as restricted stock plus stock option grants. A closed-form solution to a linear-quadratic example is provided.
Journal Article
Differences in Trading and Pricing Between Stock and Index Options
We find that the demand for stock options that increases exposure to the underlying is positively related to the individual investor sentiments and past market returns, whereas the demand for index options is invariant to these factors. These differences in trading patterns are also reflected in the differences in the composition of traders with different types of options-options on stocks are actively traded by individual investors, whereas trades in index options are more often motivated by the hedging demand of sophisticated investors. Consistent with a demand-based view of option pricing, the individual investor sentiments and past market returns are related to time-series variations in the slope of the implied volatility smile of stock options, but they have little impact on the prices of index options. The pricing impact is more pronounced in options with a higher concentration of unsophisticated investors and those with higher delta hedging costs. Our results provide evidence that factors not related to fundamentals also impact security prices.
This paper was accepted by Brad Barber, finance.
Journal Article