Option Return Predictability*

Jie Cao
The Chinese University of Hong Kong
E-mail: jiecao@[Link]

Bing Han
University of Toronto
E-mail: [Link]@[Link]

Qing Tong
Singapore Management University
E-mail: qingtong@[Link]

Xintong Zhan
The Chinese University of Hong Kong & Erasmus University Rotterdam
E-mail: xintong@[Link]

Abstract
The cross-section of delta-hedged equity option returns can be predicted by a variety of
underlying stock characteristics and firm fundamentals including idiosyncratic volatility, past
stock returns, profitability, cash holding, new share issuance, and dispersion of analyst forecasts,
although they do not significantly predict stock returns in our sample. We document new option
portfolio strategies that are profitable even after transaction costs. These profits are robust and
cannot be explained by common risk factors. The systematic patterns in the relative valuation of
options and the underlying stocks we uncover have important implications for option pricing
models and option market efficiency.

*
We thank Giovanni Barone-Adesi, Hendrik Bessembinder, Peter Carr, Hui Chen, Peter Christoffersen, Tarun Chorida,
Christopher Doffing, Nils Frieward, Ross Goran, Ruslan Goyenko, Allaudeen Hameed, Jianfeng Hu, Kris Jacobs, Robert
Kosowski, Asriel Levin, Tse-Chun Lin, Roger Loh, Dmitriy Muravyev, Chayawat Ornthanalai, Lubos Pastor, Neil Pearson, Lin
Peng, Geert Rouwenhorst, Christian Schlag, Raman Uppal, Pietro Veronesi, Christian Wagner, Jun Wang, Jason Wei, Hua Zhang,
and seminar participants at Baruch College, Chinese University of Hong Kong, Cubist Systematic Strategies, Fudan University,
Menta Capital, Morgan Stanley, Southwestern University of Finance and Economics, Singapore Management University,
Tsinghua University, Two Sigma Investments, and Yinghua Fund Management for helpful discussions and useful suggestions.
We have benefited from the comments of participants at the 10th Annual Conference on Advances in the Analysis of Hedge Fund
Strategies, the 4th Chicago Quantitative Alliance Asia Conference, the 3rd Deutsche Bank Annual Global Quantitative Strategy
Conference, the 4th OptionMetrics Research Conference, and the 6th Risk Management Conference at Mont Tremblant. The work
described in this paper is fully supported by two grants from the Research Grant Council of the Hong Kong Special
Administrative Region, China (Project No. CUHK 458212 and 14501115). All errors are our own.
 Option Return Predictability

Abstract

The cross-section of delta-hedged equity option returns can be predicted by a variety of

underlying stock characteristics and firm fundamentals including idiosyncratic volatility, past
stock returns, profitability, cash holding, new share issuance, and dispersion of analyst forecasts,
although they do not significantly predict stock returns in our sample. We document new option
portfolio strategies that are profitable even after transaction costs. These profits are robust and
cannot be explained by common risk factors. The systematic patterns in the relative valuation of
options and the underlying stocks we uncover have important implications for option pricing
models and option market efficiency.

Keywords: Equity option returns; delta-neutral call writing; stock return predictors.

JEL Classification: G02; G12; G13

1
1. Introduction
A voluminous literature has documented predictability in the cross-section of expected
stock return. Harvey, Liu, and Zhu (2016) have categorized 316 explanatory factors documented
in existing studies. Despite the tremendous growth in equity options in recent decades, however,
little is known about the determinants of expected option returns.
In this paper, we examine whether a set of variables that are well known to predict stock
returns can also predict delta-hedged equity option returns. Delta-hedging is frequently used by
option traders and market makers to reduce the total risk of an option position. By construction,
delta-hedged options are insensitive to the movements in underlying stock prices. Stock return
predictability, regardless of the underlying causes, implies predictability in raw option return via
the dependence of option prices upon the underlying stock prices. By focusing on delta-hedged
options, however, we investigate option return predictability beyond those simply inherited from
the predictability of the underlying stock returns.
Using Fama-MacBeth type cross-sectional regressions from 1996 to 2012, we find
significant predictability in daily-rebalanced delta-hedged option gains for 8 out of 12 long-
recognized stock market anomalies, 1 although such anomalies do not generate significant
abnormal profits over the same sample period in the stock market. Delta-hedged option gains
increase with size, momentum, reversal, and profitability and decrease with cash holding, analyst
forecast dispersion, new issues, and idiosyncratic volatility, but none of these variables has
significant predictive power for the cross-section of stock returns in our sample. The other four
anomalies, book-to-market, accruals, asset growth, and earnings surprise, do not significantly
affect the delta-hedged option gains. The results hold for both call and put options, with the same
signs.2 Thus, the predictability in delta-hedged option gains we document is not simply driven by
the underlying stock return predictability; otherwise, the patterns for calls and puts would have
the opposite signs.

1
The 12 anomalies we examine largely overlap with those studied by Chordia, Subrahmanyam, and Tong (2014) as well as
Stambaugh, Yu, and Yuan (2015).
2
At the end of the month, we pick one call option and one put option for each optionable stock that are closest to being at-the-
money and have a common time-to-maturity (about 50 calendar days).

2
 These systematic relations between delta-hedged option gains and various characteristics
of the underlying stocks challenge the traditional option pricing models. Stock return
predictability does not imply predictability in delta-hedged option gains under the pure no-
arbitrage option pricing models. For example, under the Black-Scholes model, the expected
delta-hedged option gains should be zero and unpredictable (e.g., Bertsimas, Kogan, and Lo
(2001)). Even in models where options are not redundant, our results are surprising. For example,
under a stochastic volatility model, Bakshi and Kapadia (2003) show that the expected delta-
hedged option gains are determined only by the volatility risk premium. Our findings are robust
to controlling for volatility risk premium and also proxies of stock jump risk.
The systematic patterns in the relative valuation between options and the underlying
stocks we document suggest a set of tradable strategies. We focus on delta-neutral covered call
writing, consisting of a short position in an approximately at-the-money equity call option and a
long position in delta shares of the underlying stock, in which delta refers to the Black-Scholes
call option delta. The delta-hedged positions are then held for a month to construct the buy-and-
hold monthly return. At the end of each month from January 1996 to December 2012, we rank
all stocks with qualified options traded into deciles by each of the 12 stock characteristics, and
we form a portfolio of delta-neutral covered call writing on stocks in each decile. Consistent with
the regression results on the cross-sectional determinants of the delta-hedged option gains, the
decile portfolio returns to delta-neutral call writing monotonically increase (or decrease) with 8
out of the 12 underlying stock characteristics. The (10-1) long-short spreads are significant
across different weighting schemes, including equal weight, and value weight by the stock
market capitalization or the market value of option open interest at the beginning of the month.
The monthly returns and Sharpe ratios of long-short portfolios, sorted according to the eight
significant stock characteristics, range from 1.28% to 3.92% and from 0.63 to 2.00 respectively.3
The results are qualitatively similar for the quintile portfolio sorts as well.

3
For each stock characteristic sort, we form a long-short portfolio of delta-neutral call writing ensuring the average long-short
monthly return spread is positive in each case.

3
 Our option strategies generate stable profits across different sample periods. During the
last decade, the stock market anomalies have weakened or become insignificant as the financial
market has become more efficient.4 The liquidity and quality of trading have also improved in
the option market.5 In contrast, the profitability of our option strategies has not diminished in
recent years, even during the 2008–2009 financial crisis. In fact, the performance has been strong
in recent years with limited downside risk. Our findings are not sensitive to seasonality, market
conditions (such as investor sentiment or stock market performance), and the macroeconomic
environment (such as The National Bureau of Economic Research (NBER) recessions versus
expansions). Moreover, the profits of our option strategies are virtually unchanged and remain
significant both economically and statistically after controlling for common stock market risk
factors or systematic volatility risk factors.6 Our findings are also robust to controlling for recent
changes in stock volatility, volatility-related mispricing, stock illiquidity, option bid-ask spread,
and option demand pressure.
Our option strategies remain profitable after taking into consideration the option
transaction costs, even when options are bought at the ask quotes and sold at the bid quotes.7
Further, our option strategies are more profitable when the underlying stocks face high arbitrage
costs (e.g., stocks with low liquidity, price, institutional ownership, and analyst coverage).
Our results could manifest some systematic mispricing between options and the
underlying stocks. Alternatively, they could be driven by exposures to unknown priced risk
factors unique to options market that are captured by various stock characteristics (these stock
characteristics are not significantly related to the expected stock return in our sample).

4
For example, Chordia et al. (2014) show that the returns of the 12 anomalies decline over time due to an increase in the
presence of hedge funds and lower trading costs. McLean and Pontiff (2015) suggest that sophisticated investors learn about
mispricing from academic publications.
5
See e.g., Figures 1–3 of Goyenko, Ornthanalai, and Tang (2015).
6
Stock market risk factors include the Fama and French (2015) five factors, momentum factor (Carhart (1997)), stock market
liquidity factor (Pastor and Stambaugh (2003)), and Kelly and Jiang (2014) tail risk factor. Systematic volatility factors including
the zero-beta straddle return of S&P 500 Index option, the value-weighted zero-beta straddle returns of S&P 500 individual stock
options, and the change in the Chicago Board Options Exchange Market Volatility Index (∆VIX).
7
Muravyev and Pearson (2015) argue that the transaction costs in options are actually smaller than commonly perceived. For an
average trade, the effective spreads that take into account of trade timing are much smaller than the conventionally measured
spreads.

4
 Our paper contributes to the literature on option return predictability. Goyal and Saretto
(2009) find that options with high implied-volatility relative to the historical volatility earn low
returns. Cao and Han (2013) document that delta-hedged equity option return decreases
monotonically with the idiosyncratic volatility of the underlying stock. Bali and Murray (2013)
construct a skewness asset from a pair of option positions and a position in the underlying stock.
They find a strong negative relation between risk-neutral skewness and the skewness asset
returns. An, Ang, Bali, and Cakici (2014) find that stocks with high past returns tend to have call
and put option contracts that exhibit increases in implied volatility over the next month. They
interpret the result as being consistent with rational models of informed trading that gives rise to
stock-level information predicting option returns.8 Boyer and Vorkink (2014) report a negative
cross-sectional relationship between returns on individual equity options and their ex-ante
skewness, consistent with investors' preference for skewness or gambling in options. Unlike
previous studies that focus the relation between option returns and various statistical properties
of underlying stock returns, we examine whether some well-known stock characteristics and firm
fundamentals can predict option returns after adjusting the exposures to the underlying stocks.
These stock characteristics have not been explored systematically in depth by the nascent
literature on option returns.
Our paper complements several recent studies that examine the implication of option
market microstructure for expected option return. Christoffersen, Goyenko, Jacobs, and Karoui
(2015) find a positive illiquidity premium in daily option returns.9 Muravyev (2015) documents
that option market order flow imbalance significantly predicts daily option returns and this
predictability is largely driven by the inventory risk faced by the market makers. Our paper has a
different focus. We study monthly delta-hedged option returns as opposed to daily option returns.
We control for option liquidity and transaction costs.

8
Unlike our study, these papers use a raw option return, or straddle return, or the change in option implied volatility as the main
variable of interest.
9
Christoffersen et al. (2015) define delta-hedged option returns as the raw option returns adjusted by the underlying stock return
multiplied by option elasticity. Unlike the adjusted option return they study, we focus on the holding return of a portfolio
consisting of an option that is delta hedged by the underlying stock.

5
 The systematic patterns in the relative valuation between options and the underlying
stocks we document support the previous finding that options are not redundant assets (e.g.,
Buraschi and Jackwerth (2001), Coval and Shumway (2001), Jones (2006)). Our paper is also
related to the literature on option market efficiency. Some tests (e.g., put-call parity violations)
are sensitive to market microstructure issues and some tests depend on specific option pricing
models. Constantinides, Jackwerth, and Perrakis (2009) use the stochastic dominance argument
to draw a model-free conclusion on mispricing of out-of-money S&P 500 call options. Their
results do not provide evidence that the options market is becoming more rational over time. Our
study does not rely on a particular option-pricing model. Our findings are consistent with
Constantinides et al. (2009), but we extend the scope of investigation to individual stock options.
The rest of the paper proceeds as follows. Section 2 describes the data and measures. In
Section 3, we present our main empirical results with a focus on the portfolio analysis of delta-
neutral call writing. Robustness analysis is also presented in Section 3. Section 4 takes into
account option transaction costs and stock limits to arbitrage. Section 5 concludes the paper.

2. Data, Delta-Hedged Option Return, and Equity Return Predictors

2.1. Data and sample coverage
We collect our sample data from both stock and equity option markets. The data process for the
option market follows Cao and Han (2013). We obtain data on U.S. individual stock options
from OptionMetrics from January 1996 to December 2012. The dataset includes the daily closing
bid and ask quotes, trading volume, and open interest of each option. Implied volatility, option's
delta, vega, and other Greeks are computed by OptionMetrics based on standard market
conventions. We obtain stock returns, prices, and trading volume from the Center for Research
on Security Prices (CRSP). The Fama-French common risk factors and the risk-free rate are
taken from Kenneth French’s website. The annual accounting data are obtained from Compustat.
The quarterly institutional holding data are from Thomson Reuters (13F) database. The analyst
coverage and forecast data are from I/B/E/S.

6
 Our analysis focuses on the options of common stocks (CRSP share codes 10 and 11). To
avoid extremely illiquid stocks, we exclude stocks with a closing price at the end of the previous
month below five dollars. At the end of each month and for each optionable stock, we extract
from the Ivy DB database of OptionMetrics a pair of options (one call and one put) that are
closest to being at-the-money and have the shortest maturity among those with more than one
month to expiration. Several filters are applied to the extracted option data. First, U.S. individual
stock options are of the American type. We exclude an option if the underlying stock paid a
dividend during the remaining life of the option. 10 The options we analyze are therefore
11
effectively European-type options. Second, in order to avoid biases related to the
microstructure, we only retain options in which the trading volume and bid quote are positive,
the bid price is strictly smaller than the ask price, and the mid-point of the bid and ask quote is at
least $1/8. Third, we exclude all option observations that violate obvious no-arbitrage
conditions.12 Fourth, we exclude options with moneyness lower than 0.8 or higher than 1.2. Fifth,
most of the options selected each month have the same maturity. We drop options whose
maturity is different from the majority of options.13 Lastly, we only retain stocks with both call
and put available after filtering.14
Our final sample contains 159,902 option-month observations for both call and put
options on individual stocks. Table 1 shows that the average moneyness of the chosen options is
1, with a small standard deviation of 0.05. The time to maturity is between 47 and 52 calendar
days, with an average of 50 days. These short-term options are most actively traded, have a
relatively smaller bid-ask spread, and provide more reliable pricing information. We utilize this

10
Including options with the underlying stocks making dividend payments before maturity does not change our results.
11
This controls for early exercise of American calls, although American puts could still contain an early exercise premium.
Nevertheless, the early exercise premium is usually small for the short-maturity options studied in our sample.
12
For example, one no-arbitrage conditions for a call option price C is S ≥ C ≥ max(0, S-Ke-rt), where S, K, T, and r are the
underlying stock price, the option strike price, the option time to maturity, and the risk-free rate, respectively.
13
Releasing any of these filters on options or the underlying stocks does not affect our main results.
14
Previous studies such as Pan and Poteshman (2006) find that the put-call ratio contains information about future stock price.
Hence, to ensure that our option data filters do not bias the distribution of the underlying stock return, we drop stocks with only
call or only put available after filtering. However, out results hold for the delta-hedged return of both call and put even after
removing such restrictions.

7
set of option data to study how expected option returns vary across the cross-section of
underlying stocks.
Appendix Table A1 reports the sample coverage of 5,179 underlying stocks. Over the
entire 204-months sample period, the average number of underlying stocks per month is 792. On
average, stocks with option retained in our sample comprise 40% of the total market
capitalization and 11% of the total number of stocks in the CRSP universe. Over 90% of the
firms have market capitalization over 300 million dollars. Relative to the full CRSP sample, the
average size percentile, book-to-market ratio percentile, and volatility percentile of stocks in our
sample are 81%, 33%, and 50%, respectively. Moreover, the average institutional ownership is
69% and the average number of analyst coverage is 11.5. Based on the 12 industries defined by
Fama and French, Panel C of Table A1 provides the industry distribution of underlying stocks,
which is similar to that in the full CSRP sample.15 Therefore, our results are unlikely to be driven
by small, illiquid, highly volatile stocks or stocks with low attention or by a few industries.

2.2. Delta-hedged option returns

2.2.1. Daily rebalanced delta-hedged gains
If an option can be perfectly replicated by the underlying stock (e.g., under the Black-Scholes
model), a delta-hedged option is riskless and should earn zero return on average. Cao and Han
(2013) find that the average delta-hedged individual stock options return is negative, which
implies that, on average, individual options are relatively overvalued compared to the underlying
stocks according to the Black-Scholes model.16
We measure a delta-hedged call option return by following Cao and Han (2013). We
first define the delta-hedged option gain, which is the change in value of a self-financing
portfolio consisting of a long call position, hedged by a short position in the underlying stock so
that the portfolio is not sensitive to stock price movements, with the net investment earning the

15
There are relatively fewer stocks in the finance industry, and slightly more stocks in the energy, and business equipment
industries.
16
Bakshi and Kapadia (2003) find a similar result of a negative delta-hedged gain and interpret it as evidence of a negative price
of volatility risk under a stochastic volatility model.

8
risk-free rate. Following Bakshi and Kapadia (2003) and Cao and Han (2013), we define the
delta-hedged gain for a call option portfolio over a period [𝑡, 𝑡 + 𝜏] as

𝑡+𝜏 𝑡+𝜏
̂ (𝑡, 𝑡 + 𝜏) = 𝐶𝑡+𝜏 − 𝐶𝑡 − ∫
∏ ∆𝑢 𝑑𝑆𝑢 − ∫ 𝑟𝑢 (𝐶𝑢 − ∆𝑢 𝑆𝑢 )𝑑𝑢, (1)
𝑡 𝑡

where 𝐶𝑡 is the call option price, ∆𝑡 = 𝜕𝐶𝑡 /𝜕𝑆𝑡 is the call option delta and 𝑟 is the risk-free rate.
The empirical analysis uses a discretized version of (1). Specifically, consider a portfolio of a
call option that is hedged discretely 𝑁 times over a period [ 𝑡, 𝑡 + 𝜏 ], where the hedge is
rebalanced at each of the dates 𝑡𝑛 (where we define 𝑡0 = 𝑡, 𝑡𝑁 = 𝑡 + 𝜏).
The discrete delta-hedged call option gain is

𝑁−1 𝑁−1
𝛼𝑛 𝑟𝑡𝑛
∏(𝑡, 𝑡 + 𝜏) = 𝐶𝑡+𝜏 − 𝐶𝑡 − ∑ ∆𝐶,𝑡𝑛 [𝑆(𝑡𝑛+1 ) − 𝑆(𝑡𝑛 )] − ∑ [𝐶(𝑡𝑛 ) − ∆𝐶,𝑡𝑛 𝑆(𝑡𝑛 )], (2)
365
𝑛=0 𝑛=0

where ∆𝐶,𝑡𝑛 is the delta of the call option on date 𝑡𝑛 , 𝑟𝑡𝑛 is the annualized risk-free rate on date 𝑡𝑛 ,
and 𝛼𝑛 is the number of calendar days between 𝑡𝑛 and 𝑡𝑛+1 . The definition for the delta-hedged
put option gain is the same as (2), except with put option price and delta replacing the call
option price and delta.
With a zero net investment initial position, the delta-hedged option gain ∏(t, t + τ) in Eq.
(2) is the excess dollar return of the delta-hedged call option. Since the option price is
homogeneous of degree one in the stock price and the strike price (see e.g., Merton (1973)),
∏(t, t + τ) is proportional to the initial stock price. To make it comparable across stocks with
different market prices, we scale the dollar return ∏(t, t + τ) by the absolute value of the
securities involved (i.e., (∆𝑡 ∗ 𝑆𝑡 – 𝐶𝑡 ) for call options and (𝑃𝑡 − ∆𝑡 ∗ 𝑆𝑡 ) for put).17
Consistent with Bakshi and Kapadia (2003) and Cao and Han (2013), Table 1 Panel A
and B show that the pooled delta-hedged option gains on average are negative for both call and
put options. For instance, the average delta-hedged option gain of at-the-money call options is -
17
We obtain similar results when we scale the delta-hedged option gains by the initial price of the underlying stocks or options.

9
1.03% over the next month and -1.26% if held until maturity which is on average 50 calendar
days. The pattern for put options is similar.

2.2.2. Monthly return to delta-neutral call writing

The delta-hedged option gain measure (scaled appropriately to make them comparable across
stocks) is theoretically motivated, but it is not convenient for a portfolio analysis and trading
practice. Since we use a self-financing portfolio, the delta-hedged option gain is not the return of
a portfolio in the traditional sense. To conduct a portfolio analysis with the buy-and-hold
approach, we consider delta-neutral call writing.18 At the end of each month, we sell one contract
of call option hedged by a long position in delta shares of the underlying stock.19 Building up
such a position requires a positive amount of capital. To avoid the high option transaction
costs,20 we hold the position for one month without rebalancing the delta-hedges for most of our
analysis.
Specifically, the return to selling a delta-neutral call over [𝑡, 𝑡 + 1] is

𝐻𝑡+1 (∆𝑡 ∙ 𝑆𝑡+1 − 𝐶𝑡+1 )

−1= − 1, (3)
𝐻𝑡 (∆𝑡 ∙ 𝑆𝑡 − 𝐶𝑡 )

where the initial investment cost is 𝐻𝑡 = (∆𝑡 ∙ 𝑆𝑡 − 𝐶𝑡 ) > 0, with C and S denoting call option
price and the underlying stock price and ∆𝑡 being the Black-Scholes call option delta at initial
time 𝑡. The payoff at the end of holding period is 𝐻𝑡+1 = (∆𝑡 ∙ 𝑆𝑡+1 − 𝐶𝑡+1 ).

Table 1 Panel C shows that the average monthly buy-and-hold return to delta-neutral call
writing is positive with an average monthly return of 3.67%. This is consistent with the negative

18
We focus on delta-hedged call options for portfolio analyses and trading strategies since at-the-money calls have a much higher
trading volume and higher frequency of trading than at-the-money puts (see, e.g., Christoffersen et al. (2015) and Goyenko et al.
(2015)). In robustness tests we document that our results hold for delta-hedged put options.
19
The delta-neutral call writing is related to but different from traditional covered call writing (also known as a “buy-write”
strategy) in which investors hold the underlying stock and sell a call option against it. The cover call writing involves the same
number of shares of stock and option (there is no delta adjustment). Therefore, a covered call position using at-the-money options
would have a positive exposure to the underlying stock.
20
As shown in Table 1 Panel A and B, the mean (median) quoted bid-ask spread of these at-the-money options is about 20%
(15%).

10
average delta-hedged option gain, which is long the options and short the underlying stock, the
opposite of delta-neutral call writing. Extending the holding period to the option maturity date
(about 50 calendar days) increases the average return to 6.05%. As a robustness check, we also
consider the daily rebalanced and compounded return to delta-neutral call writing, which has a
mean of 1.55% per month. The average monthly return of delta-neutral call writing is statistically
significant regardless of whether daily balancing of the option delta is performed.

2.3. Stock return predictors

We explore whether a host of underlying firm characteristics can predict delta-hedged option
gains and returns to delta-neutral call writing. The 12 well-known anomalies included in our
analyses are described below:

1. Ln(ME): Measured as the natural logarithm of the market value of the firm's equity (e.g., Banz
(1981) and Fama and French (1992)).

2. Ln(BM): The natural logarithm of book equity for the fiscal year-end in a calendar year
divided by market equity at the end of December of that year, as in Fama and French (1992).

3. RET(-1,0): The lagged one month return (Jegadeesh (1990)).

4. RET(-12,-2): The cumulative return on the stock over the 11 months ending at the beginning of
the previous month (Jegadeesh and Titman (1993)).

5. ACC: Accounting accruals, as measured in Sloan (1996), defined as the change in non-cash
current assets, less the change in current liabilities (exclusive of short-term debt and taxes
payable) and depreciation expenses, all divided by average total assets.

6. AG: Asset growth, as in Cooper, Gulen, and Schill (2008), computed as the year-on-year
percentage change in total assets.

11
7. CH: The cash-to-assets ratio, as in Palazzo (2012), is defined as the value of corporate cash
holdings over the value of the firm’s total assets.

8. DISP: Analyst earnings forecast dispersion, as in Diether, Malloy, and Scherbina (2002),
computed as the standard deviation of annual earnings-per-share forecasts scaled by the absolute
value of the average outstanding forecast.

9. ISSUE: New issues, as in Pontiff and Woodgate (2008), measured as the change in shares
outstanding from 11 months ago.

10. IVOL: Idiosyncratic volatility, as in Ang, Hodrick, Xing, and Zhang (2006), computed as the
standard deviation of the regression residual of individual stock returns on the Fama and French
(1993) three factors using daily data in the previous month.

11. PROFIT: Profitability, as in Fama and French (2006), calculated as earnings divided by book
equity, where earnings is defined as income before extraordinary items.

12. SUE: Standardized unexpected earnings, computed as the difference between the reported
earnings-per-share and analysts’ consensus forecast (median) scaled by the lagged stock price.
This is used as a proxy for earnings surprises in order to analyze post-earnings-announcement-
drift (PEAD) as in Bernard and Thomas (1989, 1990), Ball and Brown (1968), and Livnat and
Mendenhall (2006).
To avoid the impact of outliers in regression analyses, we winsorize all the explanatory
variables each month at the 0.5% and 99.5% levels. Panel D of Table 1 provides the summary
statistics of the 12 stock return predictors above. Due to the disparate data availability across
these variables, the number of observations varies from 109,637 to 159,892. Except for the
multivariate regression analysis, we use the maximum number of observations for each stock
return predictor to examine its impact on option returns.
Table 2 documents the time-series average of the cross-sectional correlations between

12
these stock characteristics. We also include various control variables to be used in our regression
analysis, namely the Amihud (2002)-based liquidity measure from the equity market (calculated
as the average of the daily ratio of the absolute stock return to dollar volume over the previous
month), option demand pressure (measured by option’s open interest at the end of the previous
month scaled by the total stock trading volume of last month),21 the (quoted) option bid-ask
spread (computed as the ratio of the difference between ask and bid quotes of the option over the
mid-point of the bid and ask quotes at the end of the previous month), and the VOL_deviation
(volatility mispricing measure as in Goyal and Saretto (2009), which is calculated as the log
difference between the realized volatility and Black-Scholes implied volatility for at-the-money
options at the end of last month). The correlations among these variables are generally low,
suggesting that the stock return predictors we consider are largely independent and capture
different aspects of the cross-sectional determinants of stock returns.

3. Empirical Results
In this section, we conduct cross-sectional tests between delta-hedged equity option returns and
some well-known stock return predictors. We first run cross-sectional regressions using the daily
rebalanced delta-hedged gain as the dependent variable in order to compare our results to those
reported in pervious literature. We then focus on delta-neutral call writing for portfolio analyses
and implementable option trading strategies based on the underlying firm characteristics. Finally,
we conduct various robustness checks including using alternative option return measures.

3.1. Delta-hedged option gains and equity return predictors: cross-sectional regressions
We first study how those equity characteristics affect the cross-sectional variations of delta-
hedged option gains using monthly Fama-MacBeth regressions. The dependent variable in month
t’s regression is the delta-hedged option gain until maturity (scaled to make them comparable

21
The impact of demand-pressure on the option price is documented in Bollen and Whaley (2004) and Garleanu, Pedersen, and
Poteshman (2009). Our results do not change materially if we use the option trading volume of the previous month rather than
option open interest or if we scale by the stock’s total shares outstanding.

13
across stocks)—i.e., ∏(t, t + τ)/(∆𝑡 ∗ 𝑆𝑡 – 𝐶𝑡 ) for call and ∏(t, t + τ)/(𝑃𝑡 − ∆𝑡 ∗ 𝑆𝑡 ) for put—
where the common time to maturity τ is about 50 calendar days. All independent variables are all
predetermined at time t.
Table 3 shows the univariate regressions of delta-hedged option gains on each of these 12
stock return predictors, either with or without controls. The set of control variables include stock
illiquidity (Amihud measure), option demand pressure, quoted option bid-ask spread, and
VOL_deviation. There are significantly positive coefficients for Ln(ME), RET(-1,0) , RET(-12,-2),
and PROFIT. For example, Ln(ME) has a coefficient of 0.006 in the regression with delta-
hedged call option gain as the dependent variable, with the corresponding t-statistic at 14.79. The
coefficients for CH, DISP, ISSUE, and IVOL are also significantly negative. For example, in the
regression with the delta-hedged call option gain as the dependent variable, the coefficient for
CH is -0.023 with a t-statistic of -7.62. For the other four anomalies, including Ln(BM), ACC,
AG, and SUE, we do not find robust and significant coefficients. Out of the 12 long-recognized
stock return predictors, our Fama-MacBeth regressions show that 8 stock market predictors are
also significant predictors for delta-hedged option gains. These patterns in the relative valuation
of options and stocks challenge the existing option pricing models. They also suggest a set of
profitable trading strategies in the equity option market that we explore next.

3.2. Returns to delta-neutral call writing: Portfolio sorts

In this section, we further study the relation between stock return predictors and delta-hedged
option returns using the portfolio-sorting approach. Specifically, we focus on delta-neutral call
writing on individual stocks, which consists of a short position in an at-the-money call option
and a long position of delta shares of the underlying stocks. The positions are held for a month
without modifying the delta hedge in order to construct a buy-and-hold return. At the end of each
month and for each stock return predictor examined, we sort all optionable stocks into 10 deciles
and then compare the portfolios of delta-neutral call writing on the stocks belonging to the top

14
versus the bottom decile. 22 The portfolio-sorting approach allows us to confirm our findings in
Fama-MacBeth regressions and to examine the profitability of delta-hedged option trading
strategies based on stock anomalies while accounting for transaction costs.
To ensure the robustness of portfolio analyses, we use three weighting schemes in
computing the average return of delta-neutral call writing for a portfolio: equal weight (EW),
weight by the market capitalization of the underlying stock (VW), and weight by the market
value of option open interests at the beginning of the period (Option-VW). Table 4 reports the
average return for each decile portfolio, the difference in the average returns of the top decile
(quintile), and the bottom decile (quintile) portfolios. The associated Newey-West (1987) t-
statistics are in parentheses.
We consider the (10-1) return spread first. For the EW scheme, the (10-1) spread
portfolio formed by sorting on the logarithm of the underlying stock market capitalization
Ln(ME) has a monthly return of -3.79% with a t-statistic of -23.65. For the VW (Option-VW)
case, the spread return is -3.46% (-4.01%) per month with a t-statistic of -21.81 (-14.40). Ln(BM)
does not provide a significant result for the EW spread (consistent with the previous Fama-
MacBeth regression), but it has statistically significant predictive power for a value-weighted
(either by stock or option values) portfolio of delta-hedged option returns. Past underlying stock
returns are also predictors for the return of delta-neutral call writing. The spread portfolio of
delta-neutral covered calls sorted by the past one-month stock return RET(-1,0) (resp. RET(-12,-2),
past 12-month stock return excluding the most recent month) has a monthly return of -1.28% (-
1.58%), -0.75% (-1.28%) and -1.02% (-2.02%) for EW, VW and Option-VW, respectively. All
are significant at the 1% level. For accounting accruals (ACC), the spreads are significant at the
10% level for EW and Option-VW, but with opposite signs. We therefore do not consider
accruals as a valid equity option return predictor. Asset growth (AG) provides significant
monthly spread returns ranging from -0.39% to -0.71% under different weighting schemes. Cash
holding (CH) shows strong predictive power under the EW and Option-VW schemes. Analyst

22
As a robustness check, we also rank all stocks with options traded into quintiles. We use the Black-Scholes call option delta in
reported tables. We obtain similar results if we compute the option delta using the historical GARCH volatility estimate.

15
earnings forecast dispersion (DISP), net share issuance (ISSUE) and idiosyncratic return
volatility of the underlying stock (IVOL) all strongly and positively predict the next month
returns of delta-neutral covered calls. For example, for IVOL, the spread is 3.92% per month
using EW portfolios. For PROFIT, the spread is negative and significant. For SUE, only the
spread in the EW case is significant. Similar to ACC, we do not consider it to be a valid option
return predictor.23
For the (5-1) spread, the results are comparable with the (10-1) spread though the
magnitude is generally smaller. In summary, using portfolio sorts, we find many of the 12
variables can predict the returns to delta-neutral call writing. The results are especially strong for
Ln(ME), RET(-1,0), RET(-12,-2), CH, DISP, ISSUE, IVOL, and PROFIT.

3.3. Time-series of return spreads and sub-period evidence

Panel A of Table 5 reports the time-series distribution of the equal-weighted (10-1) monthly
return spread. To ensure that all trading strategies have positive average returns, we sort on the
negative values of the following variables: Ln(ME), Ln(BM), RET(-1,0), RET(-12,-2), ACC, AG,
PROFIT, and SUE. The median return spreads are positive for all of the strategies we consider.
Seven out of twelve spreads have positive skewness. The kurtosis results show that five out of
twelve spreads exhibit a leptokurtic distribution. Sharpe ratios are generally very high for each
option strategy. For example, for PROFIT, the monthly Sharpe ratio is 1.38, which corresponds
to an annualized Sharpe ratio of 4.78.
Figure 1 plots the time-series of the equal-weighted (10-1) monthly return spreads sorted
on the eight stock characteristics that have significant predictive power for option returns.
According to Chordia et al. (2014) and McLean and Pontiff (2015), the stock market anomalies
have weakened or become insignificant in recent years because the financial market has become

23
The insignificance of accrual and SUE is consistent with a related paper by Hong, Schonberger, and Subramanyam (2015).
Hong et al. (2015) examine four accounting anomalies (accrual, earnings surprise, change in net operating asset turnover, and net
operating assets) in option return predictability. Consistent with our findings, they find that accrual and SUE cannot predict
option returns after controlling for underlying stock price movement. However, they do not investigate these eight equity
characteristics that strongly predict delta-hedged option returns in our study.

16
more efficient. Meanwhile, according to Goyenko et al. (2015), liquidity, trading volume, and
quality of trading have also gradually improved in the option market. In contrast, the profitability
of our option strategies has been very stable after 2000 and does not diminish even during the
2008–2009 financial crisis.
We further conduct a variety of sub-period analyses to gain a better understanding about
our option trading strategies. The empirical results are reported in Panel B, Table 5. We first
partition the sample into 1996–2004 and 2005–2012 periods to check whether the option market
becomes more efficient in the recent period. Despite the common view that the financial market
has become more efficient, our results do not weaken in the recent period (Column (1) and
Column (2)) as demonstrated by the fact that most predictors have significant results for both
sample periods. Furthermore, we split our sample into January and non-January groups or
according to the level of market sentiment at the beginning of the month. As shown in Columns
(3)–(6) of Table 5 Panel B, for the eight stock characteristics Ln(ME), RET(-1,0), RET(-12,-2), CH,
DISP, ISSUE, IVOL, and PROFIT that significantly spread equity option returns in Table 5
Panel A, such predictabilities are robust in both January and non-January months, both when
market sentiment is high and when it is low.24 We then examine the impact of stock market
performance and macroeconomic conditions.25 In Columns (7)–(10) of Table 5 Panel B, we find
no significant differences in the profitability of our option trading strategies between stock
market up and down periods or across different macroeconomic conditions. Finally, we split the
sample into high- and low-funding liquidity periods, according to the broker-dealer’s leverage or
a leverage factor of the corresponding quarter.26 Columns (11) and (12) show our results are
robust across periods of high- and low-funding liquidity without significant differences in the
results.

24
Baker and Wurgler (2006) construct an index of market-wide investor sentiment. The index contains six underlying measures
of investor sentiment: the average closed-end fund discount, the number of IPOs, the first-day returns of IPOs, NYSE turnover,
the equity share of total new issues, and the dividend premium.
25
The business cycle dates are from NBER: [Link]
26
The broker-dealer quarterly leverage is defined as total financial asset / (total financial asset - total financial liability) by Adrian,
Etula, and Muir (2014). The leverage factor is constructed as seasonally adjusted log changes in the level of broker-dealer
leverage. The data are obtained from Table L.129 of the Federal Reserve.
[Link]

17
3.4. Controlling for common risk factors
The analysis in Table 5 indicates that the predictability based on firm characteristics for option
returns is stable over time. It is possible, however, that our anomaly-based trading strategy
involving delta-neutral call writing is exposed to some priced risk factors. We therefore examine
whether the return of our option strategies can be explained by known common risk factors.
Specifically, we regress the time series of equal-weighted monthly returns of our option
strategies on several common risk factors and examine whether the intercept terms are
significantly different from zero.
The risk factors we control for include the five factors in Fama and French (2015),
momentum factor (Carhart (1997)), stock market liquidity risk factor (Pastor and Stambaugh
(2003)), and the Kelly and Jiang (2014) tail risk factor.27 We also control for systematic volatility
factors that include the zero-beta straddle return of the S&P 500 Index option in Coval and
Shumway (2001) as a proxy of the market volatility risk, the change in the Chicago Board
Options Exchange Market Volatility Index (∆VIX, an alternative market volatility risk as used in
Ang et al. (2006), and the value-weighted zero-beta straddle returns of S&P 500 individual stock
options (common individual stock variance risk used in Driessen, Maenhout, and Vilkov (2009)).
As shown in Panel A of Table 6, none of these systematic risk factors can explain the profits of
our option strategies. After controlling for these risk factors, all of the alphas are still highly
significant and remain similar in magnitudes as the raw returns. In Panel B of Table 6, it is
apparent that only a few factor loadings are statistically significant. Thus, our option strategies
generate abnormal profits that are largely independent of well-known common risk factors
including the aggregate market volatility risk. In unreported tests, we find that our results remain
robust after controlling for shocks to the common factor in idiosyncratic volatility (CIV) used in
Herskovic, Kelly, and Lustig (2016) during the 1996–2010 period.

27
We thank the authors for making the tail risk factor available to us.

18
3.5. Fama-MacBeth regressions
To complement previous results obtained from portfolio sorts and time-series analyses, we report
results from Fama-MacBeth cross-sectional regressions in Table 7, with returns to delta-neutral
call writing on individual stocks as the dependent variable. The key regressors are various firm
characteristics that have been shown to predict the cross-section of stock returns. We verify our
findings using Fama-MacBeth regressions. More importantly, we show the robustness of our
findings to a variety of controls including stock and option illiquidity, individual stock volatility
risk, and jump risk.28
In Table 7 Panel A, we regress returns to delta-neutral call writing on one stock return
predictor at a time with and without additional controls. The control variables in Table 7 Panel A
are (1) the Amihud measure of stock illiquidity; (2) option demand pressure (measured by the
option’s open interest at the end of the month scaled by the monthly stock trading volume) to
control for the effect identified by Garleanu, Pedersen, and Poteshman (2009); and (3) option
bid-ask spread (the ratio of the difference between ask and bid quotes of option to the midpoint
of the bid and ask quotes at the end of each month) to control for the effect identified by
Christoffersen et al. (2015); and (4) the VOL_deviation (the log difference between the realized
stock volatility and Black-Scholes implied volatility for at-the-money options) to control for the
effect identified by Goyal and Saretto (2009).
Column (1) in Table 7 Panel A shows that the coefficient estimates of eight stock
characteristics Ln(ME), RET(-1,0), RET(-12,-2), CH, DISP, ISSUE, IVOL, and PROFIT are all
significant at the 1% level and also agree in signs with the results based on portfolio sorts
reported in Tables 4, 5, and 6. Column (2) shows that the regression coefficients for seven out of
the eight stock characteristics preserve their sign and statistical significance when we include the
four control variables. The sole exception is size Ln(ME), which is significant only at the 10%
level in the presence of the controls. The sign and significance of the control variables in our

28
In addition, the sign and the statistical significance of the regression coefficients on the stock return predictors do not change
when we also control for option Greeks including delta, vega, theta, and gamma. The results are available upon request.

19
regressions are consistent with previous studies.29
In Table 7 Panel B, we control for individual stock volatility risk premium (VRP), jump
risk measures, and recent changes in realized stock volatility as well as the contemporaneous
change in option-implied volatility. The individual stock volatility risk premium is measured as
the difference between expected stock return variance over the next month under the risk-neutral
measure and the same expectation under the empirical measure. Following Jiang and Tian (2005),
Bollerslev, Tauchen, and Zhou (2009), the risk-neutral expected stock variance is extracted from
a cross section of equity options on the last trading day of each month and the empirical
counterpart is proxied by realized return variance computed from high-frequency return data
over the given month (see Cao and Han (2013) Appendix A for details). Due to data limitation
and to ensure the reliability of the variance risk premium estimates, we compute the volatility
risk premium only for about one-third of our sample of optionable stocks.
Table 7 Panel B reports a positive coefficient for individual stock variance risk premium
in all regressions, suggesting higher returns to selling delta-hedged calls on stocks with high
VRP, which is consistent with Cao and Han (2013). After controlling for VRP, the coefficients
for all of eight stock characteristics Ln(ME), RET(-1,0), RET(-12,-2), CH, DISP, ISSUE, IVOL, and
PROFIT are still significant at the 1% level and have the same signs as the cases without VRP as
a control. Therefore, individual stock variance risk premium cannot explain the significant
relation between returns to delta-neutral call writing and various firm characteristics that are
known to be related to the cross-section of stock return.
Following Bakshi and Kapadia (2003) as well as Cao and Han (2013), we control for the
jump risk by including the option-implied risk-neutral skewness and kurtosis of the underlying
stock return (see Cao and Han (2013) Appendix B for details of these measures). 30 In all
regressions, the risk-neutral skewness and kurtosis are both positively and significantly related to

29
For example, Christoffersen et al. (2015) report the return to buying delta-hedged calls increases with option illiquidity.
Consistent with their finding, we find a negative relation between return to delta-neutral call writing and option illiquidity. Goyal
and Saretto (2009) find that delta-hedged options on stocks with high-implied volatility (relative to historical volatility) earn low
returns. This is consistent with the negative regression coefficient of return to delta-neutral call writing on VOL_deviation.
30
We construct a model-free and ex-ante measure of risk neutral skewness and kurtosis by following Bakshi, Kapadia, and
Madan (2003).

20
returns to selling delta-hedged calls. This is consistent with Boyer and Vorkink (2014) as well as
with Bali and Murray (2013). More importantly, comparing the third column of Table 7 Panel B
to the first column of Table 7 Panel A reveals that controlling for risk-neutral skewness and
kurtosis of the underlying stock return does not change the sign and statistical significance of the
coefficient estimates for the eight stock characteristics Ln(ME), RET(-1,0), RET(-12,-2), CH, DISP,
ISSUE, IVOL, and PROFIT. Hence, our findings are not driven by individual stock jump risk.
Table 7 Panel B also shows that the significant relations between returns to selling delta-
hedged call options and various stock characteristics are robust to controlling for change in
realized stock volatility over the most recent six months as well as contemporaneous change in
option-implied volatility. This suggests that delta-hedged option returns are not simply driven by
changes in option-implied volatility, and our findings are not explained by stock volatility
dynamics somehow captured by stock characteristics (such as the overreaction to volatility effect
documented by Poteshman (2001)).
In Table 7 Panel C, we use multivariate analysis to determine the marginal explanatory
power for delta-hedged option returns by each stock characteristic we study. Specifically, we
regress returns to delta-neutral call writing on all the 12 stock return predictors simultaneously,
both with and without the control variables, paralleling Table 7 Panel A. We find that the
coefficients for seven characteristics (RET(-1,0), RET(-12,-2) CH, DISP, ISSUE, IVOL, and
PROFIT) remain statistically significant and have the same signs as the corresponding univariate
regression coefficients in Table 7 Panel A, with or without the controls. This suggests that delta-
neutral call-writing strategy based on each of these seven characteristics has an independent
source of profitability that could not be spanned by the other stock anomaly-based option
strategies.

3.6. Other robustness checks

3.6.1. Equity returns and stock characteristics
So far we have studied how a set of stock characteristics commonly used to predict stock returns
affects the cross-section of delta-hedged option returns By construction, the delta-hedged option

21
is not sensitive to underlying stock price movement. Therefore, the cross-section of delta-hedged
option returns should not be mechanically related to stock return predictors. To the extent that
delta hedges are not done perfectly—e.g., due to the measurement error of delta—our key results
might be driven by the underlying stock predictability. To address such concern, we check the
equity return predictability during our sample period, for both stocks covered in our sample and
stocks in the full CRSP sample. The results are reported in Appendix Table A2. During the
1996–2012 sample period, these firm characteristics have rather weak power in predicting stock
returns. The pattern is similar for both stocks covered in our study and the full CSRP sample.
This result is consistent with Chordia et al. (2014) and McLean and Pontiff (2015) that many
stock market anomalies have attenuated in recent years. Therefore, the systematic patterns in the
delta-hedged option returns cannot simply manifest the underlying stock return predictability.
Moreover, as shown in Column (1) and Column (2) of Table A2, there is no consistently positive
or negative relation between the direction of stock anomalies and the direction of option return
predictability across these 12 stock return predictors. For example, short-term reversal (RET(-1,0))
and momentum (RET(-12,-2)) predict the future stock return in the opposite direction, while both
negatively predict the return to delta-neutral call writing.

3.6.2. Variations in delta-neutral call writing

Here we verify the robustness of our findings to two variations in delta-neutral call writing. First,
so far in our portfolio analyses and trading strategies, we have only considered monthly buy-and-
hold returns of delta-neutral call writing. Strictly speaking, the position is delta-neutral only at
the beginning of the month because we do not rebalance the delta hedges as time goes by,
although the option’s delta will change as the stock price changes over time. As a robustness
check, here we consider the daily rebalanced compounded return to delta-neutral call writing in
which we readjust the option delta hedges each day and compound the daily returns of delta-
neutral call writing over the month to arrive at the monthly return. We then repeat the portfolio
sorts using the daily rebalanced and compounded return to delta-neutral call writing. Appendix
Table A3 shows that the results based on daily-rebalanced delta-neutral call writing are

22
consistent with those reported in Table 4 for all 12 equity characteristics. Therefore, our results
are robust to the daily changes of option’s delta within the one-month holding period, which
suggests that our option return predictability results are not driven by the equity exposures of the
option portfolios we consider and some patterns in the underlying stock returns.
Second, Appendix Table A4 report results based on returns of delta-neutral call writing
held until maturity (about 50 calendar days). The patterns are identical to Table 4 in which the
holding period is one month. Returns to delta-neutral call writing held until maturity increase
with the underlying stock’s idiosyncratic volatility, analyst forecast dispersion, and cash holding
and shares issuance, but decreases with the underlying stock’s market cap, past stock returns, and
profitability. All of these predictive relations are statistically significant, as in Table 4. The only
difference is that now with a longer holding period, the return spreads between the extreme
decile or quintile portfolios sorted by the underlying equity characteristics are bigger in
magnitudes than the corresponding results in Table 4. The reduced option transaction cost at
option maturity is another advantage of option trading strategies holding until maturity.

3.6.4. Strategies involving delta-neutral protective puts

In Table 3, the results of delta-hedged option gains are consistent across both call and put sorted
on various underlying stock characteristics. Now we examine whether these stock return
predictors could be used to trade put options profitably. The basic unit of analysis here is a delta-
neutral protective put. Specifically, for each stock, we buy one contract of put option against a
short position of delta shares of the underlying stock, where delta is the Black-Scholes put option
delta. Since the delta of the at-the-money put option is negative, we buy both the put option and
the underlying stock. The position is held for a month to construct a buy-and-hold return. We
then repeat the portfolios analysis of returns to delta-neutral protective puts sorted on various
stock characteristics. As shown in Appendix Table A5, the average long-short (10-1) return
spread sorted on each of these equity return predictors is always significant, with a sign that is
opposite to the counterpart of the return to delta-neutral call writing in Table 4. There are no
contradictions in these results because of the put-call parity and the fact that Table 4 uses a short

23
(delta-hedged) position for a call option, while Table A5 uses a long (delta-hedged) position for a
put option.31

3.6.5. Controlling for the impact of idiosyncratic volatility

Cao and Han (2013) document a significant relation between a delta-hedged option return and
underlying stock idiosyncratic volatility. Intuitively, delta-hedged option positions are sensitive
to volatility risk. This paper uncovers other equity characteristics that significantly predict the
cross-section of delta-hedged options. Our findings are more surprising because the lack of clear
links between a delta-hedged option and firm characteristics such as profitability, cash holding,
share issuance, and analyst forecast dispersion. Here we test and rule out the possibility that our
findings work entirely through the volatility channel—i.e., our results can be explained by Cao
and Han (2013)—and some correlations between stock idiosyncratic volatility and the new set of
equity characteristics we found to have predictive power for delta-hedged option returns.
Appendix Table A6 presents the average returns of double-sorted portfolios of delta-
neutral covered calls. Each month, we first sort optionable stocks into five quintiles (G1–G5) by
idiosyncratic volatility (IVOL). Within each quintile, we then further sort by one of the seven
new equity characteristics we find to be significant predictors of delta-hedged option returns into
five quintiles. Table A6 shows that after controlling for stock idiosyncratic volatility, each of the
seven equity characteristics (size, past one-month returns, past one-year return, cash holding,
analyst forecast dispersion, share issuance, and profitability) continues to be a significant
predictor of next month’s return of delta-neutral covered call with the same sign as the results in
Table 4 based on univariate sorts. These findings also collaborate the multivariate regression
results in Table 7 Panel C in which we show that the coefficients for the seven new equity
characteristics remain statistically significant after controlling for IVOL. Together, these results
show that the significant cross-sectional determinants of delta-hedged option returns documented
in this paper go beyond the IVOL effect in Cao and Han (2013).

31
The results for call and put have the same sign in the regressions in Table 3, because we use a long position for both call and
put when constructing the daily rebalanced delta-hedged option gains.

24
4. Impact of Option Transaction Costs and Limits to Arbitrage
In this section we examine the profitability of various stock anomaly-based option trading
strategies after accounting for option transaction costs. We also study how limits to arbitrage in
the underlying stocks affect the profitability of the option trading strategies.

4.1. Accounting for option transaction costs

For all of the previous results, we ignore option transaction costs and assume that options can be
bought or sold at the midpoint of the bid and ask price quotes. Table 8 examines the impact of
option transaction costs on the profitability of our option strategies. Due to data limitation, we
could not control for the real effective spread, which is defined as twice the difference between
the actual execution price and the market quote at the time of order entry. To take into account
the costs associated with buying or selling options, we therefore assume the effective option
spread is equal to 10%, 25%, 50%, 75%, and 100% of the quoted spread.32 Effective spread is
defined as twice the difference between the actual execution price and the market quote at the
time of order entry. The column “MidP” in Table 8 corresponds to zero effective spread—i.e.,
option returns are computed with price being equal to the midpoint of the bid and ask quotes—as
in all previous tables.
Table 8 shows that for all of the portfolio strategies sorted on the eight equity return
predictors, the equal-weighed (10-1) return spread to delta-neutral call writing decreases
monotonically with the transaction costs. In the case of new issuance (ISSUE) for example, it is
1.46% per month when measured at the midpoint of the bid and ask quotes. When the effective
option spread is 25% (50%) of the quoted spread, the average return of our option strategy is
reduced to 1.24% (1.03%). When the effective option spread increases to 75% (100%) of the
quoted spread, the average return of our option strategy further drops to 0.82% (0.62%).
However, even if the effective option spread is as large as 100% of the quoted spread, seven out

32
As shown in Table 1, the average quoted bid-ask is about 20%, with a median of 15.6%. Previous studies such as De
Fontnouvelle, Fisher, and Harris (2003) and Mayhew (2002) show that for equity options the ratio of effective spread to the
quoted spread is less than 0.5. Muravyev and Pearson (2015) also argue that for the average trade, effective spreads that take
trade timing ability into account are much smaller than conventionally measured effective spreads.

25
of eight of our option strategies still deliver positive average returns that are statistically
significant (the lone exception is the strategy based on stock size). The anomaly-based option
trading strategies therefore survive option transaction costs and can be implemented in real life.33

4.2. The impact of stock limits to arbitrage

Delta-neutral writing involves both the positions in option and underlying stocks. We further
examine how the profitability of our option strategy varies with proxies of limits to arbitrage for
the underlying stocks. In an efficient market without frictions, sophisticated investors should
fully arbitrage away predictable returns due to mispricing. However, mispricing may not
disappear completely because of limits to arbitrage (Shleifer and Vishny (1997)). If the returns of
our option strategies reflect some type of mispricing, then we should expect that these returns are
more pronounced among stocks that are more difficult to arbitrage.
We use double portfolio sorts to examine how the profits from eight option strategies
depend on proxies for limits to arbitrage. We use the previous month’s illiquidity as defined by
Amihud (2002). We also use the stock price level at the end of the previous month to proxy for
transaction costs since stocks with lower price tend to have higher percentage bid-ask spreads.
Following Nagel (2005), the percentage of institutional ownership at the end of the most recent
quarter is used as a proxy for short-sale constraints. Information uncertainty is a risk that
arbitrageurs are uncertain about the true fundamental value of their arbitrage positions.
Following Zhang (2006), we use analyst coverage, measured as the number of analysts following
the firm in the previous month, to proxy for information uncertainty.
Each month, we first sort our sample into five quintiles (G1–G5) by 1/Amihud (2002)
measure for liquidity, stock price level for bid-ask spread, institutional ownership for short-sale
constraints, or analyst coverage for information uncertainty. Within each quintile, we then
further sort by eight equity characteristics into five quintiles. Table 9 shows that the average

33
Using intra-day transaction data for options with various moneyness and maturity between 30 and 182 calendar days, Goyenko
et al. (2015) find that in aggregate, the effective-to-quoted spread ratio has decreased from 1 to 0.8. The effective-to-quoted
spread ratio would be far below 0.8 for these short-term maturity ATM options used in our study.

26
long-short return spread by various option strategies is significantly higher for Group 1, that is,
illiquid and low priced stocks, stocks with low institutional holding, and stocks followed by
fewer analysts. This finding is consistent with limits to arbitrage hypothesis—i.e., the existence
of option return predictability is related to trading frictions.
Furthermore, the difference in the anomaly-based long-short option trading profits
between the highest and lowest arbitrage cost groups is significant for all of these eight option
strategies. In the case of cash holding (CH) for example, the difference in the long-short portfolio
returns between the low- and high-liquidity portfolios is 147 basis points per month; between
low and high priced stocks it is 133 basis points; across the institutional ownership portfolios it is
155 basis points, and across the analyst coverage portfolios it is 135 basis points. In all cases, the
difference in the long-short portfolio returns between the high- and low-arbitrage cost portfolios
is statistically and economically significant. This suggests that the profits of option strategies are
difficult to arbitrage amongst stocks with lower liquidity, price level, institutional ownership, or
analyst coverage. These results highlight again that stock limits to arbitrage play an important
role in explaining the significant relation between delta-hedged option returns and the eight
equity characteristics found in this paper.

5. Conclusion
This paper documents a novel and surprising finding that many well-known stock characteristics
could significantly predict delta-hedged option returns, even after their predictive power for the
stock returns have diminished or become insignificant. Consistent with relative mispricing
between options and the underlying stocks, we uncover a set of profitable trading strategies that
involve delta-neutral call options based on the underlying stock characteristics and firm
fundamentals. These strategies produce stable profits over time and across a wide range of
market conditions. The profitability remains strong for daily-rebalanced delta-hedged options,
and similar results hold for delta-neutral protective put strategies. More importantly, their return
profitability cannot be explained by common stock market risk factors or volatility risk factors.
Even after accounting for realistic option transaction costs, most of the option strategies based on

27
stock characteristics and firm fundamentals still yield both statistically and economically
significant profits.
Our paper examines the option return predictability from a new but important
perspective—i.e., underlying firm fundamentals and stock characteristics—thereby
complementing the existing literature that concentrates on the effects of statistical moments of
the underlying stock return (such as volatility or skewness). We find that stock market anomalies
can explain the cross-section of delta-hedged option returns. Besides the salient trading
implications, our paper also adds to the literature on option market price efficiency.
It is surprising that the profitability of our option strategies does not decline over time
given the fact that the stock market has become more efficient and the liquidity and quality of
trading of the option market have also been improved. A plausible explanation is the insufficient
arbitrage activities in the option market. Option traders tend to focus on volatility-related
information and neglect other stock characteristics. In addition, they usually cover a limited
number of stocks and their corresponding options, and do not conduct long-short portfolio
trading that prevails in the stock market. Our results challenge existing option-pricing models.
More research is needed to better understand the option return predictability documented in this
paper.

28
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33
 Appendix: Variable Definitions

Delta-Hedged Option Return Measures

Delta-hedged gain, as in Bakshi and Kapadia (2003), defined as the change (over the
next month or until option maturity) in the value of a portfolio consisting of one
contract of long option position and a proper amount of the underlying stock re-
hedged daily so that the portfolio is not sensitive to stock price movement. As in Cao
Delta-hedged gains
and Han (2013), the call option delta-hedged gain is scaled by (∆*S-C), where ∆ is
the Black-Scholes option delta, S is the underlying stock price, and C is the price of
call option. The put option delta-hedged gain is scaled by (P-∆*S), where P is the
price of a put option.

For each stock at the end of the previous month, we sell one contract of call option
Returns to delta-neutral call against a long position of ∆ shares of the underlying stock, where ∆ is the Black-
writing Scholes call option delta. The position is held for one month or until maturity to
compute the buy-and-hold return.
As in Cao and Han (2013), for each stock at the end of the previous month, we sell
one contract of call option against a long position of ∆ shares of the underlying
Daily rebalanced and
stock, where ∆ is the Black-Scholes call option delta. We then adjust the delta-hedge
compounded monthly
on each trading day by buying or selling the proper amount of stock, keeping the
returns to delta-neutral call
option position to be one contract until the end of month when it is closed out. The
writing
daily buy-and-hold return is compounded over the month to arrive at the monthly
return.

Stock Return Predictors

The natural logarithm of the market value of the firm's equity. See Banz(1981) and
Ln(ME)
Fama and French (1992).

The natural logarithm of book equity for the fiscal year-end in a calendar year
Ln(BM) divided by market equity at the end of December of that year, as in Fama and French
(1992).

RET(-1,0) The lagged one month return (Jegadeesh (1990)).

The cumulative return on the stock over the 11 months ending at the beginning of
RET(-12,-2)
the previous month (Jegadeesh and Titman (1993)).

Accounting accruals, as measured in Sloan (1996), defined as the change in non-cash

ACC current assets, less the change in current liabilities (exclusive of short-term debt and
taxes payable) and depreciation expenses, all divided by average total assets.

Asset growth, as in Cooper, Gulen, and Schill (2008), computed as the year-on-year
AG
percentage change in total assets.

Cash-to-assets ratio, as in Palazzo (2012), defined as the value of corporate cash

CH
holdings over the value of the firm’s total assets.

Analyst earnings forecast dispersion, as in Diether, Malloy, and Scherbina (2002),

DISP computed as the standard deviation of annual earnings-per-share forecasts scaled by
the absolute value of the average outstanding forecast.
 New issues, as in Pontiff and Woodgate (2008), measured as the change in shares
ISSUE
outstanding from 11 months ago.

Annualized idiosyncratic volatility, as in Ang, Hodrick, Xing, and Zhang (2006),

IVOL computed as the standard deviation of the regression residuals of the Fama and
French (1993) three-factor model using daily data within the previous month.

Profitability, as in Fama and French (2006), calculated as earnings divided by book

PROFIT
equity in which earnings are defined as income before extraordinary items.

Most recent standardized unexpected earnings within previous three months,

computed as the difference between the reported earnings-per-share and analysts’
SUE
consensus forecast (median), scaled by the lagged stock price. See Livnat and
Mendenhall (2006).

Control Variables

The natural logarithm of illiquidity, calculated as the average of the daily Amihud
Ln(Amihud)
(2002) illiquidity measure over the previous month.

(Option open interest / stock volume)×103. Option open interest is the total number
Option demand pressure of option contracts that are open at the end of the previous month. Stock volume is
the stock trading volume over the previous month.

The ratio of the difference between the bid and ask quotes of option to the midpoint
Option bid-ask spread
of the bid and ask quotes at the end of previous month.

Volatility mispricing, as in Goyal and Saretto (2009), calculated as the log difference
between the realized volatility and Black-Scholes implied volatility for at-the-money
VOL_deviation
options at the end of last month. The realized volatility is the standard deviation of
daily stock returns over the previous month.

Volatility risk premium, defined as the difference between the square root of realized
variance estimated from intradaily stock returns over the previous month and the
VRP
square root of a model free estimate of the risk-neutral expected variance implied
from stock options at the end of the month.

The risk-neutral skewness and kurtosis of stock returns, as in Bakshi, Kapadia, and
Option-implied skewness
Madan (2003), are inferred from a cross section of out of the money calls and puts at
and kurtosis
the beginning of the period.

Change in realized volatility, defined as the difference between the realized daily
∆VOL return volatility of last month and the previous six months’ average realized
volatility.

Ln (IVt / IVt-1) The contemporaneous change in option-implied volatility.

Institutional ownership The percentage of common stocks owned by institutions in the previous quarter.

Analyst coverage The number of analysts following the firm in the previous month.

35
 Table 1: Summary Statistics
This table reports the descriptive statistics of option returns and equity characteristics used to predict delta-hedged option returns. The option sample
period is from January 1996 to December 2012. In Panel A (Panel B), call (put) option delta-hedged gain is the change over the next month or until
option maturity in the value of a portfolio consisting of one contract of long call (put) position and a proper amount of the underlying stock, re-hedged
daily so that the portfolio is not sensitive to stock price movement. The call option delta-hedged gain is scaled by (∆*S-C), where ∆ is the Black-Scholes
option delta, S is the underlying stock price, and C is the price of call option. The put option delta-hedged gain is scaled by (P-∆*S), where P is the price
of put option. Moneyness is the ratio of stock price to option strike price. Days to maturity is the number of calendar days until the option expiration.
Vega is the option vega according to the Black-Scholes model scaled by the stock price. Option bid-ask spread is the ratio of the difference between ask
and bid quotes of option to the midpoint of the bid and ask quotes at the end of each month. In Panel C, delta-neutral call writing strategy is as follows:
for each stock, we sell one contract of call option and delta hedge by a long position of ∆ shares of the underlying stock, where ∆ is the Black-Scholes
call option delta. The position is held for one month or until maturity to compute the buy-and-hold return. For the daily rebalanced returns, the delta-
hedges are rebalanced daily, and we then compound the daily returns of the rebalanced delta-neutral call writing over the month to arrive at the monthly
return. Panel D reports the time-series average of cross-sectional statistics of equity return predictors. All of these variables are winsorized each month at
the 0.5% level. Ln(ME) represents the logarithm of market capitalization in billions of U.S. dollars. Ln(BM) is the logarithm of the book-to-market ratio.
RET(-1,0) is the lagged one month return. RET(-12,-2) is the cumulative returns over the second through twelfth months prior to the current month. ACC
represents accruals as measured as in Sloan (1996). AG is the asset growth computed in Cooper, Gulen and Shill (2008). CH is the cash-to-assets ratio as
in Palazzo (2012). DISP is the analyst earnings forecast dispersion, as in Diether, Malloy, and Scherbina (2002). ISSUE represents new issues as in
Pontiff and Woodgate (2008). IVOL is the annualized idiosyncratic volatility computed as in Ang, Hodrick, Xing, and Zhang (2006). PROFIT is the
profitability as in Fama and French (2006). SUE is the difference between the reported earnings-per-share and analysts’ consensus forecast (median),
scaled by the lagged stock price.

Standard 10th Lower Upper 90th

Variable Mean Median
deviation percentile quartile quartile percentile
Panel A: Call Options (15,9902 observations)
Delta-hedged gain until maturity / (∆*S – C) (%) -1.26 7.70 -7.65 -4.11 -1.49 0.92 4.48
Delta-hedged gain until month-end / (∆*S – C) (%) -1.03 4.67 -5.46 -2.97 -1.10 0.70 3.34
Moneyness = S/K (%) 100.26 4.46 95.00 97.50 100.00 102.80 105.64
Days to maturity 50 2 47 50 50 51 52
Vega 0.14 0.01 0.13 0.14 0.14 0.15 0.15
Quoted option bid-ask spread (%) 19.29 15.56 5.57 8.80 14.65 24.77 39.19

36
 Standard 10th Lower Upper 90th
Variable Mean Median
deviation percentile quartile quartile percentile
Panel B: Put Options (15,9902 observations)
Delta-hedged gain until maturity / (P - ∆*S) (%) -1.25 5.77 -6.73 -3.75 -1.46 0.76 4.09
Delta-hedged gain until month-end / (P - ∆*S) (%) -0.87 3.88 -4.71 -2.67 -1.01 0.62 3.02
Moneyness = S/K (%) 100.24 4.47 95.00 97.50 100.00 102.80 105.63
Days to maturity 50 2 47 50 50 51 52
Vega 0.14 0.01 0.13 0.14 0.14 0.15 0.15
Quoted option bid-ask spread (%) 20.53 16.36 5.96 9.48 15.61 26.39 41.54

Panel C: Returns to Delta-Neutral Call Writing Strategy

Buy & hold until month-end (%) 3.67 5.81 -1.48 1.40 3.52 6.13 9.45
Buy & hold until maturity (%) 6.05 11.46 -4.27 1.55 6.08 11.36 17.64
Daily rebalanced & compounded until month-end (%) 1.55 5.69 -3.19 -0.22 1.61 3.73 6.66

Panel D: Equity Characteristics Summary (Time-Series Average of Cross-Sectional Statistics)

Standard 10th Lower Upper 90th
Variable Obs Mean Median
deviation percentile quartile quartile percentile
Ln(ME) 143,667 7.60 1.50 5.82 6.51 7.41 8.55 9.68
Ln(BM) 143,434 -1.10 0.80 -2.12 -1.59 -1.04 -0.55 -0.14
RET(-1,0) (%) 159,772 1.76 13.62 -13.54 -6.22 1.02 8.73 17.67
RET(-12,-2) (%) 157,714 27.85 69.38 -32.45 -11.70 13.22 46.47 98.57
ACC 127,559 -0.04 0.08 -0.12 -0.07 -0.04 0.00 0.05
AG 152,959 0.67 3.53 -0.09 0.01 0.13 0.34 0.90
CH 140,238 0.23 0.23 0.01 0.04 0.14 0.36 0.59
DISP (%) 154,084 27.94 234.09 0.86 1.62 3.46 8.98 23.51
ISSUE 155,567 0.05 0.13 -0.04 -0.01 0.01 0.05 0.17
IVOL 159,892 0.41 0.22 0.18 0.25 0.36 0.51 0.69
PROFIT 149,375 0.04 0.47 -0.20 0.03 0.12 0.19 0.28
SUE (%) 109,637 0.06 0.59 -0.15 -0.01 0.05 0.16 0.38
37
 Table 2: Time-Series Average of Cross-Sectional Correlations
The table presents cross-sectional Pearson correlations of all variables used in the cross-sectional regressions. The equity characteristics used to predict delta-
hedged option returns are described in Table 1. Ln(Amihud) is the logarithm of Amihud (2002) illiquidity measure. Option demand is measured by the option’s
open interest at the end of the month scaled by the monthly stock trading volume. Option bid-ask is the ratio of the difference between the ask and bid quotes of
the option to the midpoint of the bid and ask quotes at the end of each month. The VOL_deviation is the log difference between the realized volatility and Black-
Scholes implied volatility for at-the-money options. We compute the correlations each month and report the time-series average of these correlations. The
sample period is from January 1996 to December 2012.

Ln RET RET Ln Option Option VOL_

ACC AG CH DISP ISSUE IVOL PROFIT SUE
(BM) (-1,0) (-12,-2) (Amihud) demand bid-ask deviation

Ln(ME) -0.089 -0.041 -0.084 -0.050 0.001 -0.275 -0.065 -0.149 -0.407 0.215 -0.014 -0.906 -0.044 -0.370 0.048
Ln(BM) 0.018 0.003 0.001 -0.026 -0.355 0.015 -0.027 -0.115 0.095 0.006 0.103 -0.003 0.154 0.000
RET(-1,0) -0.004 -0.008 -0.009 0.015 -0.001 -0.006 0.086 -0.026 0.060 0.011 0.041 -0.033 0.144
RET(-12,-2) -0.053 -0.012 0.095 -0.015 0.139 0.058 -0.102 0.091 -0.072 -0.027 -0.103 0.019
ACC 0.091 -0.011 -0.020 -0.007 0.010 0.150 -0.01 0.046 -0.003 0.013 0.002
AG 0.017 0.003 0.069 0.034 0.003 0.004 0.005 0.001 -0.014 -0.002
CH 0.039 0.118 0.293 -0.239 0.028 0.207 0.029 -0.029 -0.027
DISP 0.021 0.055 -0.054 -0.037 0.061 0.008 0.027 -0.003
ISSUE 0.170 -0.164 -0.007 0.088 -0.004 -0.002 0.023
IVOL -0.185 -0.006 0.350 -0.046 0.033 0.538
PROFIT -0.009 -0.194 -0.040 -0.056 0.029
SUE -0.012 0.006 -0.029 0.015
Ln(Amihud) 0.069 0.462 -0.034
Option
0.007 -0.105
demand
Option
-0.010
bid-ask

38
 Table 3: Delta-Hedged Option Gains and Equity Characteristics
This table reports the average coefficients from monthly Fama-MacBeth regressions of delta-hedged option
gains until maturity for both call options and put options. The equity characteristics used to predict delta-hedged
option returns are described in Table 1. In the “Without Controls” column, the regressions are the univariate
regressions with each equity predictor as the independent variable. In the “With Controls” column, the
independent variables are one of the equity predictors and control variables. The unreported control variables
include Ln(Amihud) (the Amihud (2002) illiquidity measure’s logarithm), option demand pressure (measured by
option’s open interest at the end of the month scaled by the monthly stock trading volume), option bid-ask
spread (the ratio of the difference between the ask and bid quotes of the option to the midpoint of the bid and ask
quotes at the end of each month) and the VOL_deviation (the log difference between the VOL and the Black-
Scholes implied volatility for at-the-money options). All independent variables are winsorized each month at the
0.5% level. The sample period is from January 1996 to December 2012. To adjust for serial correlation, robust
Newey-West (1987) t-statistics are reported in brackets.

Call Options Put Options

Delta-hedged gain until maturity Delta-hedged gain until maturity
Dependent Variable
(∆*S-C) (P - ∆*S)
Without Controls With Controls Without Controls With Controls

Ln(ME) 0.006*** -0.002** 0.004*** -0.001

(14.79) (-2.34) (13.76) (-1.08)
Ln(BM) 0.00 0.002*** 0.001 0.001***
(0.84) (3.95) (1.27) (3.09)
RET(-1,0) 0.020*** 0.014*** 0.004 -0.001
(5.57) (4.38) (1.62) (-0.33)
RET(-12,-2) 0.006*** 0.005*** 0.004*** 0.003***
(4.78) (4.44) (4.32) (4.01)
ACC 0.002 0.009*** -0.003 0.001
(0.47) (2.61) (-0.89) (0.39)
AG -0.000* -0.000* -0.000** -0.000**
(-1.94) (-1.86) (-2.31) (-2.11)
CH -0.023*** -0.014*** -0.017*** -0.010***
(-7.62) (-5.30) (-8.01) (-5.36)
DISP -0.003*** -0.002*** -0.002*** -0.001***
(-4.72) (-4.25) (-3.88) (-3.24)
ISSUE -0.018*** -0.013*** -0.014*** -0.010***
(-5.99) (-5.04) (-5.53) (-4.48)
IVOL -0.038*** -0.074*** -0.027*** -0.057***
(-14.86) (-23.31) (-11.32) (-18.68)
PROFIT 0.014*** 0.009*** 0.010*** 0.006***
(13.00) (11.33) (10.64) (7.96)
SUE 0.054 0.024 0.030 0.026
(0.70) (0.33) (0.52) (0.45)

39
 Table 4: Returns to Delta-Neutral Call Writing Sorted on Equity Characteristics
This table reports the average monthly returns of delta-neutral call writing sorted on the underlying equity characteristics. The equity characteristics used
to predict delta-hedged option returns are described in Table 1. At the end of each month, we rank all stocks with options traded into deciles by the equity
characteristics. For each stock, we sell one contract of call option against a long position of ∆ shares of the underlying stock, where ∆ is the Black-
Scholes call option delta. The position is held for one month without rebalancing the delta-hedges. We use three weighting schemes in computing the
average return to delta-neutral call writing for a portfolio of stocks: equal weight (EW), weight by the market capitalization of the underlying stock (VW),
and weight by the market value of option open interest at the beginning of the period (Option-VW). The table reports the return for each decile portfolio
and the spread return that is long in the tenth decile and short in the first decile. We also rank all stocks with options traded into quintiles by the equity
characteristics and the spread return that is long in the fifth quintile and short in the first quintile is reported. All returns in this table are expressed in
percent. The sample period is from January 1996 to December 2012. To adjust for serial correlation, robust Newey-West (1987) t-statistics are reported
in brackets.

(10-1) (5-1)
1 2 3 4 5 6 7 8 9 10
Spread Spread
Ln (ME)
EW 5.94 4.86 4.21 3.81 3.56 3.25 2.93 2.76 2.45 2.15 -3.79*** -3.10***
(30.83) (27.95) (26.57) (24.34) (22.94) (21.40) (21.83) (19.43) (16.72) (17.21) (-23.65) (-23.97)
VW 5.49 4.54 3.97 3.56 3.35 3.06 2.83 2.59 2.35 2.03 -3.46*** -2.79***
(28.38) (27.43) (25.88) (22.41) (20.98) (19.69) (20.91) (19.49) (17.23) (16.65) (-21.81) (-23.03)
Option-VW 6.16 5.68 4.76 3.98 3.85 3.67 3.04 2.87 2.67 2.15 -4.01*** -3.70***
(21.72) (16.70) (22.71) (15.23) (16.68) (20.14) (15.01) (12.88) (13.88) (13.78) (-14.40) (-13.67)

Ln (BM)
EW 3.82 3.78 3.64 3.48 3.51 3.42 3.54 3.44 3.49 3.80 -0.02 -0.15
(20.78) (22.97) (22.70) (24.05) (26.11) (23.82) (23.38) (23.74) (22.84) (21.89) (-0.10) (-1.19)
VW 2.23 2.23 2.34 2.25 2.30 2.32 2.43 2.37 2.36 2.68 0.45*** 0.29**
(13.70) (15.93) (18.43) (16.78) (18.74) (17.62) (17.49) (16.18) (15.31) (14.94) (2.81) (2.35)
Option-VW 2.91 2.86 3.07 2.71 2.85 2.78 2.82 3.00 2.93 3.75 0.84*** 0.43**
(12.41) (14.75) (20.36) (14.71) (18.21) (14.39) (15.21) (14.62) (14.29) (13.59) (2.96) (2.00)
RET(-1,0)
EW 5.38 4.08 3.58 3.35 3.17 3.01 3.09 3.22 3.41 4.10 -1.28*** -0.97***
(26.68) (23.61) (23.04) (24.48) (22.22) (21.10) (21.65) (24.06) (23.17) (22.96) (-8.08) (-7.88)
VW 3.97 2.94 2.49 2.23 2.26 2.06 2.07 2.11 2.37 3.23 -0.75*** -0.60***
(17.20) (16.07) (16.11) (17.59) (19.21) (15.93) (15.40) (12.00) (15.04) (16.38) (-3.69) (-3.78)
Option-VW 5.03 3.70 3.06 2.67 2.55 2.41 2.44 2.50 2.89 4.00 -1.02*** -0.81***
(19.15) (16.43) (15.91) (16.04) (13.59) (13.79) (16.20) (11.31) (14.08) (13.87) (-3.61) (-3.87)

40
RET(-12,-2)
EW 5.44 4.11 3.65 3.36 3.14 3.09 3.10 3.14 3.38 3.86 -1.58*** -1.16***
(24.07) (20.62) (24.20) (20.50) (23.15) (24.12) (25.62) (22.54) (21.73) (20.04) (-7.20) (-6.48)
VW 4.11 3.04 2.51 2.34 2.25 2.17 2.19 2.21 2.30 2.83 -1.28*** -0.89***
(17.04) (15.18) (17.04) (16.95) (18.72) (16.36) (19.40) (15.96) (13.29) (13.37) (-4.48) (-4.16)
Option-VW 5.28 3.61 3.19 2.80 2.41 2.63 2.53 2.38 2.65 3.26 -2.02*** -1.45***
(17.29) (15.64) (15.70) (14.78) (15.84) (16.77) (15.83) (11.83) (11.73) (11.94) (-5.22) (-5.16)

ACC
EW 4.26 3.70 3.58 3.39 3.34 3.27 3.38 3.69 3.90 4.10 -0.16* 0.02
(26.43) (23.86) (24.53) (26.24) (25.99) (22.60) (22.25) (23.92) (24.01) (26.13) (-1.79) (0.39)
VW 2.90 2.51 2.34 2.31 2.15 2.17 2.26 2.48 2.58 2.84 -0.06 0.06
(18.19) (15.80) (13.17) (18.75) (16.04) (16.71) (18.24) (18.72) (15.73) (17.67) (-0.50) (0.63)
Option –VW 3.44 3.03 2.74 2.88 2.81 2.71 2.84 3.23 3.13 3.81 0.37* 0.23
(16.95) (13.75) (11.91) (16.97) (15.25) (13.95) (15.37) (16.78) (14.83) (17.96) (1.72) (1.41)

AG
EW 4.61 3.61 3.24 3.16 3.20 3.25 3.35 3.54 3.90 4.21 -0.39*** -0.05
(24.96) (24.02) (25.18) (24.84) (22.91) (22.93) (21.56) (22.26) (23.34) (23.59) (-3.46) (-0.48)
VW 2.88 2.53 2.28 2.23 2.16 2.13 2.35 2.49 2.47 2.56 -0.33** -0.17
(18.20) (19.80) (20.85) (18.65) (15.99) (14.78) (15.21) (13.24) (16.54) (11.75) (-1.98) (-1.47)
Option-VW 4.07 3.24 2.79 2.72 2.59 2.39 2.70 2.88 3.08 3.36 -0.71*** -0.50**
(15.92) (18.95) (21.20) (18.63) (16.44) (15.15) (9.91) (13.35) (15.26) (11.35) (-2.89) (-2.45)

CH
EW 3.21 3.10 3.17 3.32 3.48 3.74 3.87 4.01 4.21 5.19 1.99*** 1.55***
(20.39) (25.15) (21.32) (22.13) (23.11) (24.90) (23.45) (22.89) (22.72) (27.05) (13.47) (11.63)
VW 2.46 2.16 2.19 2.29 2.24 2.42 2.58 2.66 2.70 2.67 0.21 0.24
(16.87) (19.29) (16.54) (19.13) (16.82) (16.48) (15.69) (11.13) (13.28) (9.53) (0.80) (1.29)
Option-VW 2.72 2.74 2.70 2.72 3.10 3.04 3.03 3.01 3.08 3.77 1.05*** 0.55**
(15.49) (17.78) (15.00) (16.68) (19.78) (15.17) (15.63) (12.23) (11.16) (12.32) (3.50) (2.16)

DISP
EW 2.81 2.76 2.94 3.09 3.34 3.49 3.80 4.11 4.45 4.84 2.03*** 1.86***
(22.29) (23.15) (23.47) (22.31) (23.65) (23.35) (23.39) (23.60) (25.64) (25.03) (17.09) (19.25)
VW 2.02 2.15 2.08 2.19 2.40 2.41 2.52 2.66 3.01 3.52 1.51*** 1.09***
(16.31) (18.85) (17.87) (16.32) (17.67) (15.94) (14.68) (14.36) (16.31) (17.14) (9.13) (8.06)
Option-VW 2.16 2.31 2.41 2.54 2.69 2.85 2.96 3.30 3.82 4.59 2.43*** 1.93***
(10.21) (22.15) (18.59) (17.12) (16.44) (13.07) (14.67) (12.98) (16.64) (14.62) (9.32) (9.60)

41
ISSUE
EW 2.95 2.87 3.15 3.51 3.68 3.78 3.86 3.90 4.06 4.41 1.46*** 1.33***
(23.45) (23.61) (24.40) (23.86) (23.87) (24.10) (22.02) (22.74) (24.64) (25.71) (13.18) (14.86)
VW 2.33 2.06 2.18 2.25 2.42 2.45 2.46 2.66 2.51 2.79 0.46*** 0.49***
(19.17) (21.06) (17.95) (17.27) (17.84) (14.50) (14.63) (16.39) (13.57) (15.04) (3.59) (4.49)
Option-VW 2.66 2.09 2.70 2.78 3.11 3.21 3.27 3.26 3.38 3.45 0.79*** 1.05***
(20.85) (12.19) (16.70) (17.16) (16.67) (18.71) (14.97) (14.04) (15.25) (10.77) (2.71) (5.56)

IVOL
EW 2.03 2.38 2.75 3.09 3.35 3.67 3.94 4.39 4.84 5.95 3.92*** 3.19***
(20.53) (21.16) (24.24) (22.58) (22.57) (24.27) (22.98) (23.85) (24.29) (27.62) (24.93) (23.32)
VW 1.80 2.04 2.15 2.46 2.70 2.86 3.15 3.43 3.75 4.79 2.98*** 2.28***
(16.38) (18.33) (16.04) (17.09) (18.09) (15.62) (17.07) (17.05) (15.95) (18.95) (15.29) (13.07)
Option-VW 1.83 1.91 2.12 2.52 2.99 3.12 3.51 4.04 4.56 5.54 3.71*** 3.15***
(17.39) (11.79) (11.86) (17.42) (17.79) (15.60) (14.78) (16.89) (15.87) (16.58) (12.68) (12.62)

PROFIT
EW 5.45 4.31 3.87 3.52 3.39 3.13 3.15 2.96 3.03 3.06 -2.39*** -1.83***
(27.26) (22.95) (27.30) (22.29) (23.04) (23.77) (22.13) (21.92) (22.62) (22.89) (-18.62) (-17.30)
VW 3.79 3.01 2.73 2.54 2.40 2.24 2.26 2.14 2.17 2.09 -1.71*** -1.18***
(16.72) (15.66) (17.55) (12.38) (17.60) (18.82) (17.55) (17.27) (18.50) (14.97) (-9.23) (-8.75)
Option-VW 4.96 3.73 3.36 3.19 2.77 2.76 2.71 2.50 2.51 2.37 -2.59*** -1.95***
(14.53) (14.80) (16.48) (11.36) (18.40) (15.57) (15.69) (15.21) (18.17) (14.17) (-8.84) (-8.89)

SUE
EW 4.00 3.10 2.99 2.58 2.65 2.88 3.00 3.06 3.28 3.81 -0.19*** -0.05
(22.77) (23.22) (21.38) (18.56) (21.11) (21.39) (23.02) (23.36) (22.83) (23.81) (-2.87) (-0.82)
VW 2.78 2.31 2.23 2.06 2.12 2.17 2.21 2.26 2.32 2.59 -0.18 -0.03
(17.35) (16.84) (17.84) (15.91) (18.52) (14.86) (14.25) (15.20) (14.15) (14.02) (-1.25) (-0.27)
Option-VW 3.72 2.69 2.55 2.26 2.19 2.47 2.20 2.50 2.72 3.57 -0.14 -0.06
(15.61) (14.38) (15.58) (12.74) (11.60) (13.19) (10.44) (15.80) (11.93) (18.07) (-0.75) (-0.38)

42
 Table 5: The Long-Short Return Spread of Delta-Neutral Call-Writing Portfolio Strategies
The equity characteristics used to predict delta-hedged option returns are described in Table 1. At the end of each month, we rank all stocks with
options traded into deciles by each of the equity characteristics. For each stock, we construct a delta-neutral call writing position that sells one
contract of call option against a long position of ∆ shares of the underlying stock, where ∆ is the Black-Scholes call option delta. We compute the
holding period return of a spread portfolio that is long delta-neutral covered calls on stocks ranked in the tenth decile and short delta-neutral covered
calls on stocks ranked in the first decile. Panel A of this table reports the time-series distribution of the equal-weighted (10-1) return spread. Panel B
reports the equal-weighted (10-1) return spreads for different subsamples. The sentiment index is constructed by Baker and Wurgler (2006). The
business cycle dates are from The National Bureau of Economic Research (NBER). The broker-dealer’s quarterly leverage is defined by Adrian,
Etula, and Muir (2014) and obtained from the Federal Reserve. The sample period is from January 1996 to December 2012.

Panel A: A Time-Series Distribution of Delta-Neutral Call-Writing Return Spread Sorted on Various Equity Characteristics

Sorted on Equal-Weighted (10-1) Return Spread

Excess
Mean Min 10-Pctl Q1 Med Q3 90-Pctl Max Std Skewness Sharpe Ratio
Kurtosis

– Ln(ME) 3.79*** -2.73 1.81 2.52 3.61 4.78 6.10 11.15 1.89 0.51 1.57 2.00
– Ln(BM) 0.02 -10.92 -2.26 -0.97 0.13 1.25 2.20 13.12 2.35 -0.16 7.97 0.01
– RET(-1,0) 1.28*** -3.76 -1.07 0.00 1.04 2.48 4.03 9.23 2.01 0.52 0.92 0.63
– RET(-12,-2) 1.58*** -4.72 -0.99 0.15 1.27 2.63 4.32 11.89 2.44 1.17 2.80 0.65
*
– ACC 0.16 -3.20 -1.30 -0.65 0.10 0.86 1.79 4.13 1.22 0.12 0.45 0.13
– AG 0.39*** -4.45 -0.98 -0.28 0.39 1.13 1.94 6.51 1.30 0.03 3.12 0.30
***
+ CH 1.99 -5.00 -0.20 1.02 2.10 3.15 3.99 7.45 1.97 -0.51 1.85 1.01
+ DISP 2.03*** -4.09 0.26 1.19 2.07 2.84 3.84 6.39 1.54 -0.47 1.89 1.32
+ ISSUE 1.46*** -7.15 0.18 0.79 1.58 2.38 3.08 7.10 1.65 -1.68 7.50 0.88
***
+ IVOL 3.92 -3.16 1.70 2.68 3.70 5.12 6.77 14.47 2.22 0.53 3.18 1.77
– PROFIT 2.39*** -5.38 0.67 1.59 2.39 3.23 4.48 8.16 1.73 -0.64 3.68 1.38
– SUE 0.19*** -3.69 -1.05 0.49 0.18 0.84 1.70 3.19 1.08 0.01 0.57 0.18

43
 Panel B: Sub-Period Analysis

Sorted on Equal-Weighted (10-1) Return Spread

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)

Broker- Broker-
1996– 2005– Sentiment Sentiment Negative Positive NBER NBER
January Feb-Dec dealer dealer
2004 2012 Low High Mkt Ret Mkt Ret Recession Expansion Leverage Leverage
Low High
# of Months 102 102 17 187 102 102 78 126 26 135 102 102

– Ln(ME) 4.12*** 3.41*** 3.87*** 3.78*** 3.57*** 3.48*** 3.91*** 3.98*** 3.21*** 3.91*** 4.02*** 3.56***
(15.67) (25.73) (6.54) (22.79) (16.20) (14.67) (17.37) (20.39) (11.08) (17.37) (15.75) (19.90)
– Ln(BM) 0.10 0.07 0.28 0.01 0.31 0.20 0.19 0.15 0.16 0.19 -0.48** 0.52**
(0.36) (0.40) (0.31) (0.03) (1.30) (0.63) (0.87) (0.59) (0.28) (0.87) (-2.27) (2.23)
– RET(-1,0) 1.73*** 0.77*** 2.22* 1.19*** 1.20*** 1.12*** 1.56*** 1.38*** 0.97** 1.56*** 1.44*** 1.12***
(7.17) (5.50) (2.11) (8.02) (5.77) (5.11) (7.83) (6.67) (2.25) (7.83) (5.24) (6.65)
– RET(-12,-2) 2.10*** 1.00*** 2.78** 1.48*** 1.08*** 1.34*** 1.66*** 1.74*** 2.93*** 1.66*** 1.14*** 2.03***
(6.31) (4.32) (2.60) (6.56) (3.16) (4.19) (6.01) (5.44) (5.23) (6.01) (3.25) (8.17)
– ACC 0.22 0.09 0.31 0.15 0.30*** 0.01 0.16 0.25** 0.09 0.16 0.26** 0.06
(1.55) (0.92) (1.73) (1.57) (2.75) (0.06) (1.57) (2.34) (0.24) (1.57) (2.50) (0.41)
– AG 0.32 0.48*** 0.35 0.40*** 0.73*** 0.30 0.32** 0.45*** 0.19 0.32** 0.67*** 0.12
(1.60) (5.10) (1.48) (3.31) (5.33) (1.54) (2.09) (3.23) (1.16) (2.09) (4.89) (0.81)
+ CH 2.04*** 1.93*** 1.57** 2.02*** 1.79*** 1.92*** 2.01*** 2.03*** 2.26*** 2.01*** 1.61*** 2.36***
(7.96) (15.59) (2.69) (12.85) (9.79) (10.69) (9.88) (8.57) (5.61) (9.88) (6.85) (15.79)
+ DISP 1.92*** 2.16*** 2.36*** 2.00*** 2.06*** 1.46*** 1.82*** 2.38*** 2.43*** 1.82*** 2.13*** 1.93***
(10.30) (15.57) (6.05) (16.72) (12.40) (8.29) (12.44) (20.29) (6.76) (12.44) (13.13) (11.38)
+ ISSUE 1.25*** 1.71*** 1.34** 1.47*** 1.47*** 1.01*** 1.36*** 1.74*** 1.52*** 1.36*** 1.51*** 1.41***
(6.81) (17.76) (2.24) (12.47) (9.39) (4.57) (8.72) (12.44) (6.47) (8.72) (10.15) (7.79)
+ IVOL 4.36*** 3.42*** 4.57*** 3.86*** 3.95*** 3.23*** 4.02*** 4.35*** 4.04*** 4.02*** 3.85*** 3.99***
(18.66) (22.18) (5.39) (22.70) (21.02) (11.21) (18.54) (20.65) (8.92) (18.54) (18.87) (17.06)
– PROFIT 2.48*** 2.29*** 2.71*** 2.36*** 2.60*** 1.92*** 2.36*** 2.68*** 2.41*** 2.36*** 2.56*** 2.22***
(10.97) (23.11) (16.85) (16.75) (18.18) (9.49) (13.41) (18.80) (6.90) (13.41) (12.70) (13.94)
– SUE 0.27** 0.11 0.35 0.24*** 0.10 0.15 0.22*** 0.22** 0.27 0.22*** 0.13 0.25**
(2.50) (1.46) (1.57) (3.41) (0.96) (1.31) (2.65) (2.53) (1.02) (2.65) (1.53) (2.33)

44
 Table 6: Alphas and Factor Loadings of Delta-Neutral Covered Calls Strategies
The equity characteristics used to predict delta-hedged option returns are described in Table 1. At the end of
each month, we rank all stocks with options traded into deciles by the equity characteristics. For each stock, we
sell one contract of call option against a long position of ∆ shares of the underlying stock, where ∆ is the Black-
Scholes call option delta. We compute the spread return that is long in the tenth decile and short in the first
decile. Panel A reports the return spread and alphas on several common risk factors. αCAPM is the alpha from
CAPM. αCarhart-4 is calculated from the Carhart (1997) four-factor model. αFF-5 is calculated from the Fama
and French (2015) five-factor model. α9-factor is calculated from a nine-factor model with Fama and French
(2015) five-factors, the Pastor and Stambaugh (2003) liquidity factor, the Coval and Shumway (2001) zero-beta
straddle return of the S&P 500 Index option (ZB-STRAD-Index), the value-weighted zero-beta straddle returns
of S&P 500 individual stock options (ZB-STRAD-Stock), and change in the Chicago Board Options Exchange
Market Volatility Index (∆VIX). α10-factor is calculated from a ten-factor model that includes all the factors in
α9-factor plus the Kelly and Jiang (2014) tail risk factor. Panel B reports the factor loadings for the ten-factor
model. The sample period is from January 1996 to December 2012. To adjust for serial correlation, robust
Newey-West (1987) t-statistics are reported in brackets.

Panel A: Raw Returns and Risk-Adjusted Returns of Equal-Weighted (10-1) Return Spread

Sorted on Raw Return αCAPM αCarhart-4 αFF-5 α9-factor α10-factor

– Ln(ME) 3.79*** 3.76*** 3.71*** 3.69*** 3.86*** 3.89***

(23.65) (24.25) (23.38) (21.47) (20.40) (20.06)
– Ln(BM) 0.02 0.00 0.07 0.15 0.14 0.09
(0.10) (0.01) (0.39) (0.77) (0.64) (0.42)
– RET(-1,0) 1.28*** 1.26*** 1.25*** 1.29*** 1.23*** 1.28***
(8.08) (8.04) (7.89) (7.80) (5.59) (6.00)
– RET(-12,-2) 1.58*** 1.56*** 1.60*** 1.59*** 1.77*** 1.84***
(7.20) (6.92) (7.08) (6.52) (6.83) (7.63)
– ACC 0.16* 0.14 0.16* 0.16* 0.20 0.21
(1.79) (1.55) (1.86) (1.78) (1.58) (1.59)
– AG 0.39*** 0.39*** 0.38*** 0.33*** 0.26* 0.26*
(3.46) (3.33) (3.47) (3.03) (1.96) (1.96)
+ CH 1.99*** 1.99*** 1.99*** 1.96*** 1.94*** 1.90***
(13.47) (13.95) (14.13) (13.01) (10.42) (10.28)
+ DISP 2.03*** 1.98*** 2.02*** 1.94*** 1.99*** 1.97***
(17.09) (15.55) (16.47) (15.21) (13.84) (13.36)
+ ISSUE 1.46*** 1.42*** 1.45*** 1.40*** 1.29*** 1.27***
(13.18) (11.77) (11.85) (9.77) (7.46) (7.13)
+ IVOL 3.92*** 3.86*** 3.91*** 3.86*** 3.98*** 4.00***
(24.93) (22.76) (22.75) (21.54) (18.12) (17.48)
– PROFIT 2.39*** 2.34*** 2.36*** 2.35*** 2.34*** 2.32***
(18.62) (18.79) (19.72) (18.04) (15.21) (14.24)
– SUE 0.19*** 0.19*** 0.18** 0.15** 0.12 0.12
(2.87) (2.68) (2.55) (2.03) (1.24) (1.22)

45
 Panel B: Exposures of Equal-Weighted (10-1) Return Spread to Common Risk Factors

Equal-Weighted (10-1) Return Spread Sorted on

– – – – – – + + + + – –
Ln(ME) Ln(BM) RET(-1,0) RET(-12,-2) ACC AG CH DISP ISSUE IVOL PROFIT SUE

Alpha10-factor 3.890 0.086 1.282 1.839 0.210 0.264 1.901 1.968 1.266 3.996 2.325 0.123
(20.06) (0.42) (6.00) (7.63) (1.59) (1.96) (10.28) (13.36) (7.13) (17.48) (14.24) (1.22)
MKT-RF 0.110 -0.098 0.033 0.137 0.005 0.080 -0.065 0.028 -0.013 -0.029 0.018 0.032
(1.78) (-1.77) (0.55) (2.41) (0.14) (2.51) (-1.23) (0.77) (-0.31) (-0.55) (0.35) (1.00)
SMB 0.114 -0.043 -0.040 0.086 0.028 -0.017 0.101 0.090 0.113 0.099 0.090 0.029
(2.27) (-0.65) (-0.84) (1.34) (0.89) (-0.41) (1.97) (2.74) (3.16) (1.79) (1.63) (0.94)
HML -0.049 0.022 -0.083 -0.088 -0.009 0.011 0.020 -0.118 -0.095 -0.062 -0.028 0.010
(-0.76) (0.36) (-1.19) (-1.33) (-0.23) (0.28) (0.39) (-2.86) (-1.95) (-1.13) (-0.64) (0.27)
RMW 0.093 -0.068 -0.063 0.091 0.003 0.088 0.117 0.070 0.057 0.074 0.070 0.061
(1.31) (-0.68) (-0.98) (1.03) (0.07) (1.28) (1.62) (1.31) (0.74) (1.00) (1.09) (1.35)
CMA -0.007 -0.263 0.107 -0.123 -0.120 0.033 -0.116 -0.024 -0.015 -0.203 -0.125 -0.034
(-0.08) (-1.69) (1.16) (-1.10) (-2.01) (0.56) (-1.33) (-0.37) (-0.16) (-1.88) (-1.97) (-0.61)
LIQ -0.009 0.044 0.007 -0.040 -0.001 -0.006 0.052 -0.004 0.019 -0.015 0.039 -0.018
(-0.45) (1.77) (0.26) (-1.32) (-0.07) (-0.40) (2.08) (-0.27) (1.03) (-0.65) (1.72) (-1.10)
ZB-STRAD-INDEX 0.015 -0.003 -0.010 0.010 0.010 -0.002 -0.002 0.014 -0.002 0.009 -0.001 0.003
(2.85) (-0.32) (-1.66) (1.58) (2.72) (-0.41) (-0.25) (3.38) (-0.42) (1.16) (-0.18) (1.04)
ZB-STRAD-STOCK -0.017 0.006 0.008 0.000 -0.028 -0.006 0.006 -0.038 -0.019 -0.029 -0.002 -0.014
(-1.41) (0.36) (0.61) (0.02) (-3.66) (-0.58) (0.39) (-3.72) (-1.50) (-1.79) (-0.14) (-1.80)
ΔVIX 0.046 -0.090 -0.009 0.099 0.001 0.046 -0.039 -0.052 -0.047 -0.152 -0.047 0.022
(0.70) (-1.54) (-0.14) (1.93) (0.01) (1.75) (-0.70) (-1.61) (-1.14) (-3.05) (-0.90) (0.72)
TAILRISK -0.355 0.643 -0.724 -0.923 -0.083 -0.109 0.555 0.284 0.311 -0.245 0.236 0.013
(-1.15) (2.40) (-2.93) (-2.90) (-0.64) (-0.74) (1.70) (1.27) (1.63) (-0.79) (0.80) (0.13)
Adj. R2 0.081 0.077 0.059 0.139 0.088 0.015 0.063 0.284 0.201 0.212 0.129 0.005

46
 Table 7: Fama-MacBeth Regressions for Returns to Delta-Neutral Call Writing
This table reports the average coefficients from monthly Fama-MacBeth regressions of the returns to delta-neutral call writing. For each stock, we sell
one contract of call option hedged by a long position of ∆ shares of the underlying stock, where ∆ is the Black-Scholes call option delta. The position is
held for one month without rebalancing delta hedges during the holding period. Equity characteristics used to predict delta-hedged option returns are
described in Table 1. Panel A and B present the results for one equity characteristics at a time. Panel C presents the results using all 12 variables. The
control variables include Ln(Amihud) (the logarithm of Amihud illiquidity measure), option demand pressure (measured by the option’s open interest at
the end of the month scaled by the monthly stock trading volume), option bid-ask spread (the ratio of the difference between ask and bid quotes of option
to the midpoint of the bid and ask quotes at the end of each month ), VOL_deviation (the log difference between the realized volatility and Black-Scholes
implied volatility for at-the-money options), VRP (the volatility risk premium is defined as the difference between the square root of realized variance
estimated from intradaily stock returns over the previous month and the square root of a model free estimate of the risk-neutral expected variance implied
from stock options at the end of the month), option-implied skewness and kurtosis (the risk-neutral skewness and kurtosis of stock returns inferred from a
cross section of out of the money calls and puts at the beginning of the period), ∆VOL (the change in volatility is defined as the difference between
previous month’s realized daily return volatility and the previous six months’ average realized volatility), and Ln (IVt /IVt-1) (the contemporaneous change
in the option-implied volatility of the same option over the same month). The sample period is from January 1996 to December 2012. To adjust for serial
correlation, robust Newey-West (1987) t-statistics are reported in brackets.

47
 Panel A: Using the Individual Stock Return Predictor as a Regressor

Without Controls With Control Variables

Stock return Stock return Option Option

Ln(Amihud) VOL_deviation
predictor predictor demand pressure bid-ask spread

Ln(ME) -0.007*** -0.002* 0.006*** -0.003 -0.017*** -0.013***

(-25.38) (-1.90) (7.38) (-0.72) (-2.77) (-10.16)
Ln(BM) -0.001 -0.002*** 0.007*** -0.004 -0.015*** -0.013***
(-1.46) (-4.36) (20.83) (-0.84) (-2.68) (-10.81)
RET(-1,0) -0.022*** -0.020*** 0.007*** 0.001 -0.021*** -0.013***
(-7.67) (-7.51) (20.86) (0.25) (-3.35) (-10.84)
RET(-12,-2) -0.005*** -0.003*** 0.007*** -0.003 -0.021*** -0.014***
(-4.52) (-3.26) (21.35) (-0.72) (-3.36) (-10.90)
ACC -0.002 -0.009*** 0.007*** 0.001 -0.017*** -0.014***
(-0.68) (-3.42) (23.04) (0.14) (-3.05) (-10.66)
AG 0.000 0.000 0.007*** -0.003 -0.018*** -0.014***
(1.08) (0.88) (22.46) (-0.70) (-3.22) (-10.42)
CH 0.027*** 0.017*** 0.006*** -0.003 -0.015** -0.014***
(14.87) (9.97) (17.22) (-0.70) (-2.28) (-10.64)
DISP 0.002*** 0.002*** 0.007*** -0.005 -0.020*** -0.013***
(5.16) (4.24) (21.05) (-1.25) (-3.15) (-10.47)
ISSUE 0.028*** 0.020*** 0.007*** -0.003 -0.018*** -0.014***
(10.67) (8.62) (21.37) (-0.78) (-3.16) (-10.66)
IVOL 0.052*** 0.080*** 0.002*** 0.005 0.001 -0.047***
(26.99) (27.93) (6.00) (1.44) (0.20) (-27.11)
PROFIT -0.013*** -0.008*** 0.007*** -0.005 -0.017*** -0.013***
(-15.47) (-10.66) (19.66) (-1.19) (-2.94) (-10.10)
SUE -0.013 -0.022 0.005*** -0.012*** -0.012** -0.008***
(-0.25) (-0.44) (17.18) (-2.80) (-2.39) (-7.05)

48
 Panel B: Controlling for Volatility Risk Premium, Jump Risk, and Changes in Volatility

Control for Control for Control for

Volatility Risk Premium Jump Risk Changes in Volatility
Option- Option-
Stock return Stock return Stock return
VRP implied implied ∆VOL Ln (IVt /IVt-1)
predictor predictor predictor
Skewness Kurtosis
Ln(ME) -0.004*** 0.093*** -0.005*** 0.003*** 0.103*** -0.007*** 0.005*** -0.163***
(-11.69) (15.51) (-17.87) (8.49) (8.48) (-28.93) (2.66) (-23.49)
Ln(BM) 0.001 0.100*** 0.000 0.004*** 0.130*** -0.000 0.003 -0.162***
(0.80) (13.39) (0.87) (9.83) (9.53) (-1.01) (1.46) (-23.49)
RET(-1,0) -0.013*** 0.098*** -0.012*** 0.004*** 0.124*** -0.009*** 0.002 -0.165***
(-3.39) (13.97) (-4.10) (9.46) (9.71) (-3.46) (1.06) (-22.83)
RET(-12,-2) -0.003*** 0.101*** -0.003*** 0.004*** 0.131*** -0.004*** 0.003* -0.164***
(-3.33) (13.83) (-3.39) (9.76) (9.04) (-4.27) (1.81) (-23.02)
ACC 0.004 0.103*** -0.001 0.004*** 0.129*** 0.001 0.003 -0.166***
(0.81) (13.61) (-0.26) (9.08) (9.06) (0.29) (1.27) (-23.60)
AG -0.000 0.100*** 0.000 0.004*** 0.130*** 0.000 0.003* -0.164***
(-1.32) (13.69) (0.40) (9.52) (9.19) (1.13) (1.66) (-23.41)
CH 0.010*** 0.100*** 0.015*** 0.004*** 0.120*** 0.024*** 0.004** -0.170***
(3.91) (14.66) (7.02) (8.73) (8.92) (15.46) (2.12) (-22.29)
DISP 0.005*** 0.099*** 0.002** 0.004*** 0.119*** 0.003*** 0.003 -0.163***
(3.34) (13.80) (2.32) (9.45) (9.46) (6.14) (1.31) (-22.83)
ISSUE 0.012*** 0.100*** 0.012*** 0.004*** 0.128*** 0.022*** 0.004** -0.164***
(3.64) (14.08) (4.91) (9.48) (9.38) (10.59) (2.03) (-23.13)
IVOL 0.033*** 0.093*** 0.036*** 0.003*** 0.093*** 0.067*** -0.042*** -0.161***
(12.85) (15.96) (18.01) (8.22) (8.63) (27.85) (-17.63) (-22.17)
PROFIT -0.006*** 0.099*** -0.008*** 0.004*** 0.121*** -0.013*** 0.004** -0.162***
(-4.14) (13.95) (-8.82) (9.35) (8.76) (-16.97) (2.36) (-23.34)
SUE -0.082 0.092*** 0.021 0.003*** 0.111*** 0.020 0.003 -0.146***
(-0.67) (13.18) (0.27) (8.48) (7.86) (0.31) (1.40) (-22.99)

49
Panel C: Using Multiple Equity Characteristics Simultaneously as Regressors

(1) (2)

Without Controls With Controls

Intercept 0.047*** 0.004

(17.67) (1.12)
Ln(ME) -0.003*** 0.005***
(-12.46) (7.65)
Ln(BM) 0.001 0.001***
(1.48) (2.89)
RET(-1,0) -0.025*** -0.013***
(-10.13) (-5.71)
RET(-12,-2) -0.005*** -0.002***
(-5.91) (-2.88)
ACC -0.004 -0.002
(-1.18) (-0.75)
AG -0.000 -0.001*
(-0.57) (-1.71)
CH 0.006*** 0.003**
(3.96) (2.29)
DISP 0.004*** 0.002***
(4.65) (3.43)
ISSUE 0.004** 0.003*
(2.10) (1.76)
IVOL 0.030*** 0.074***
(14.11) (25.47)
PROFIT -0.003*** -0.001*
(-3.53) (-1.68)
SUE 0.060 0.125**
(0.89) (1.98)
Ln(Amihud) 0.006***
(8.61)
Option demand pressure 0.000
(0.03)
Option bid-ask spread 0.002
(0.38)
VOL_deviation -0.039***
(-19.38)
Average adj. R2 0.113 0.166

50
 Table 8: Impact of Option Transaction Costs on the Return of Option Portfolio Strategy
This table reports the impact of stock options’ transaction costs on the profitability of our option-trading strategy based on the equity characteristics. Equity
characteristics used to predict delta-hedged option returns are described in Table 1. Each month and for each optionable stock, we sell one contract of short-
maturity at-the-money option, delta-hedged with the underlying stock, and rebalance the delta-hedges each month. The position is held for one month to compute
the buy-and-hold return. For the column “MidP,” we assume the options are transacted at the midpoint of the bid and ask quotes (i.e., effective spread is zero). The
other columns correspond to different assumptions on the ratio of effective bid-ask spread (ESPR) to the quoted bid-ask spread (QSPR). All of the numbers in this
table are expressed in percent. The sample period is from January 1996 to December 2012. To adjust for serial correlation, robust Newey-West (1987) t-statistics
are reported in brackets.

Sorted on Equal-Weighted (10-1) Return Spread Equal-Weighted (5-1) Return Spread

Effective Bid-Ask Spread / Quoted Bid-Ask Spread Effective Bid-Ask Spread / Quoted Bid-Ask Spread

MidP 10% 25% 50% 75% 100% MidP 10% 25% 50% 75% 100%

– Ln(ME) 3.79*** 3.37*** 2.76*** 1.75*** 0.75*** -0.22 3.10*** 2.76*** 2.26*** 1.43*** 0.62*** -0.18
(23.65) (20.71) (16.28) (9.42) (3.67) (-0.95) (23.97) (20.84) (16.25) (9.33) (3.63) (-0.92)
– RET(-1,0) 1.28*** 1.22*** 1.14*** 1.00*** 0.86*** 0.73*** 0.97*** 0.93*** 0.87*** 0.73*** 0.59*** 0.49***
(8.08) (7.88) (7.54) (6.86) (6.04) (5.13) (7.88) (7.64) (7.18) (6.61) (5.57) (4.62)
– RET(-12,-2) 1.58*** 1.45*** 1.25*** 0.98*** 0.73*** 0.42*** 1.16*** 1.06*** 0.91*** 0.69*** 0.48*** 0.24**
(7.20) (6.91) (6.33) (5.63) (-4.44) (2.89) (6.48) (6.22) (5.71) (4.94) (3.82) (2.17)
+ CH 1.99*** 1.89*** 1.74*** 1.51*** 1.27*** 1.04*** 1.55*** 1.47*** 1.36*** 1.17*** 0.99*** 0.81***
(13.47) (13.14) (12.57) (11.44) (10.07) (8.48) (11.63) (11.28) (10.71) (9.65) (8.44) (7.11)
+ DISP 2.03*** 1.87*** 1.64*** 1.26*** 0.88*** 0.51*** 1.86*** 1.72*** 1.51*** 1.17*** 0.83*** 0.50***
(17.09) (16.03) (14.34) (11.27) (8.00) (4.65) (19.25) (18.05) (16.16) (12.77) (9.18) (5.54)
+ ISSUE 1.46*** 1.37*** 1.24*** 1.03*** 0.82*** 0.62*** 1.33*** 1.24*** 1.12*** 0.92*** 0.72*** 0.53***
(13.18) (12.80) (12.08) (10.47) (8.43) (6.17) (14.86) (14.20) (13.11) (11.04) (8.72) (6.31)
+ IVOL 3.92*** 3.68*** 3.32*** 2.74*** 2.17*** 1.61*** 3.19*** 2.99*** 2.69*** 2.19*** 1.71*** 1.24***
(24.93) (23.82) (22.00) (18.59) (14.85) (10.97) (23.32) (22.17) (20.32) (16.95) (13.33) (9.61)
– PROFIT 2.39*** 2.20*** 1.92*** 1.46*** 1.00*** 0.56*** 1.83*** 1.67*** 1.43*** 1.05*** 0.66*** 0.29***
(18.62) (17.30) (15.22) (11.60) (7.92) (4.33) (17.30) (16.03) (14.02) (10.43) (6.68) (2.90)

51
 Table 9: Impact of Limits to Arbitrage on the Returns of the Option Portfolio Strategies
This table reports the equal-weighted average return spread in various subsamples. Each month, we first sort our sample into five quintiles (G1–G5) by
stock liquidity defined as the 1/Amihud (2002) measure, stock price level, institutional ownership, or analyst coverage. Within each quintile, we then
further sort by the equity characteristics into five quintiles. All of the numbers in this table are expressed in percent. The sample period is from January
1996 to December 2012. To adjust for serial correlation, robust Newey-West (1987) t-statistics are reported in brackets.
Equal-Weighted (5-1) Return Spread across Arbitrage Cost Measure Quintiles
Stock Stock Institutional Analyst Stock Stock Institutional Analyst
Sorted on
Liquidity Price Ownership Coverage Liquidity Price Ownership Coverage
– Ln(ME) G1-Low 2.09*** 1.54*** 4.14*** 2.75*** + DISP G1-Low 1.42*** 0.70*** 2.41*** 1.60***
(12.22) (7.80) (23.87) (15.83) (8.95) (5.52) (13.44) (12.38)
3 0.80*** 0.92*** 2.58*** 2.12*** 3 1.35*** 0.31*** 1.44*** 1.73***
(4.42) (7.45) (19.02) (14.46) (10.86) (2.69) (10.61) (13.59)
G5-High 0.45*** 0.66*** 1.56*** 1.50*** G5-High 0.62*** 0.16 1.17*** 1.26***
(2.82) (5.87) (13.80) (13.62) (4.26) (1.33) (8.77) (8.54)
(G5-G1) -1.64*** -0.88*** -2.58*** -1.25*** (G5-G1) -0.80*** -0.55*** -1.23*** -0.34*
(-7.14) (-3.87) (-13.40) (-6.25) (4.20) (-3.51) (-7.25) (-1.91)
– RET(-1,0) G1-Low 1.03*** 0.83*** 1.13*** 1.27*** + ISSUE G1-Low 1.43*** 1.56*** 1.98*** 1.56***
(6.04) (4.99) (5.64) (6.00) (9.67) (9.30) (11.55) (10.96)
3 1.05*** 0.47*** 0.77*** 0.97*** 3 0.91*** 0.55*** 1.07*** 0.86***
(6.65) (3.35) (5.79) (6.43) (8.37) (4.17) (10.66) (6.03)
G5-High 0.58*** 0.20 0.84*** 0.59*** G5-High 0.21 0.15 0.51*** 0.62***
(3.97) (1.46) (6.30) (4.15) (1.34) (1.12) (4.05) (4.86)
(G5-G1) -0.46** -0.63*** -0.29 -0.68*** (G5-G1) -1.22*** -1.41*** -1.47*** -0.94***
(-2.54) (-3.38) (-1.44) (-3.25) (-6.09) (-7.38) (-10.00) (-5.19)
– RET(-12,-2) G1-Low 0.89*** 0.36* 1.32*** 0.91*** + IVOL G1-Low 2.74*** 2.98*** 4.11*** 3.53***
(4.54) (1.77) (4.97) (4.09) (18.06) (20.02) (23.56) (18.30)
3 0.65*** -0.39*** 0.97*** 1.44*** 3 2.37*** 1.44*** 2.65*** 2.52***
(3.61) (-2.78) (5.38) (7.68) (14.52) (8.73) (15.60) (14.93)
G5-High 0.52*** -0.07 0.86*** 1.14*** G5-High 1.33*** 0.90*** 2.11*** 1.94***
(2.90) (-0.41) (4.65) (5.88) (7.12) (6.11) (14.37) (10.32)
(G5-G1) -0.37 -0.43* -0.45* 0.23 (G5-G1) -1.40*** -2.08*** -2.00*** -1.59***
(-1.60) (-1.70) (-1.85) (1.17) (-8.30) (-11.64) (-11.28) (-8.30)
+ CH G1-Low 1.87*** 1.74*** 2.14*** 1.85*** – PROFIT G1-Low 1.76*** 1.12*** 2.58*** 1.95***
(10.38) (10.96) (10.95) (10.83) (12.24) (8.19) (17.24) (12.08)
3 1.03*** 0.86*** 1.20*** 1.17*** 3 0.94*** 0.31** 1.54*** 1.17***
(5.81) (6.24) (6.95) (6.76) (7.62) (2.45) (12.12) (6.77)
G5-High -0.52*** 0.41*** 0.59*** 0.50** G5-High 0.38*** 0.11 0.89*** 0.94***
(-2.90) (2.73) (3.41) (2.56) (2.65) (0.70) (6.87) (8.67)
(G5-G1) -1.47*** -1.33*** -1.55*** -1.35*** (G5-G1) -1.38*** -1.01*** -1.69*** -1.01***
(6.60) (-6.69) (-7.66) (-7.40) (-8.45) (-5.61) (-9.34) (-5.86)

52
 Figure 1. Time-series return spread to delta-neutral call writing.
This figure plots the time-series of an equal-weighted (10-1) return spread to delta-neutral call writing sorted on the equity characteristics. The equity
characteristics used to predict delta-hedged option returns are described in Table 1. At the end of each month, we rank all stocks with options traded into
deciles by the equity characteristics. All return spreads in this figure are expressed in percent. The sample period is from January 1996 to December
2012.
– Ln(ME) – RET(-1,0)
1996-2000 2001-2004 2005-2008 2009-2012 1996-2000 2001-2004 2005-2008 2009-2012
12 10
10 8
8 6
6 4
4 2
2 0
0 -2
-2 -4
-4 -6

– RET(-12,-2) + CH
1996-2000 2001-2004 2005-2008 2009-2012 1996-2000 2001-2004 2005-2008 2009-2012
12 10
10 8
8 6
6
4
4
2
2
0
0
-2 -2
-4 -4
-6 -6

53
 + DISP + ISSUE
1996-2000 2001-2004 2005-2008 2009-2012 1996-2000 2001-2004 2005-2008 2009-2012
8 8
6 6

4 4
2
2
0
0
-2
-2 -4
-4 -6
-6 -8

+ IVOL – PROFIT
1996-2000 2001-2004 2005-2008 2009-2012 1996-2000 2001-2004 2005-2008 2009-2012
16 10
14 8
12
6
10
8 4
6 2
4 0
2
-2
0
-2 -4
-4 -6

54
 Table A1: Sample Coverage of Underlying Stocks
This table provides details about the stock-month sample for the underlying stocks with qualified option
observations of both call and put. At the end of each month, we extract from the Ivy DB database of
OptionMetrics one call and one put on each optionable common stock whose price is above $5. The selected
options are approximately at-the-money with a common maturity of about one-and-a-half month. We exclude
the following option observations: moneyness is lower than 0.8 or higher than 1.2; the option price violates
obvious no-arbitrage option bounds; the reported option trading volume is zero; the option bid quote is zero or
the midpoint of the bid and ask quotes is less than $1/8; and the underlying stock paid a dividend during the
remaining life of the option. Panel A reports the time-series summary statistics and Panel B reports the time-
series average of cross-sectional distributions. Panel C reports the time-series average of a Fama-French 12-
industry distribution for the sample of stocks with qualified option observations and full CRSP sample. Percent
coverage of stock universe (EW) is the number of sample stocks, divided by the total number of CRSP stocks.
The percent coverage of the stock universe (VW) is the total market capitalization of sample stocks divided by
the total market value of all CRSP stocks. Firm size is the firm’s market capitalization. Book-to-market is the
fiscal year-end book value of common equity divided by the calendar year-end market value of equity. Volatility
is the standard deviation of daily stock returns over one month. The size, book-to-market, and volatility
percentiles are defined using the full CRSP sample. Institutional ownership is the percentage of common stocks
owned by institutions in the previous quarter. Analyst coverage is the number of analysts following the firm in
the previous month. The sample period is from January 1996 to December 2012.
Panel A: Time-Series Distribution (204 Monthly Obs)
Jan 1996–Dec 2012 Mean Std 10-Pctl Q1 Med Q3 90-Pctl
Number of stocks in the sample each month 792 162 575 705 806 901 1,000
Stock % coverage of stock universe (EW) 10.87 2.58 7.47 9.54 10.90 12.55 14.33
Stock % coverage of stock universe (VW) 40.26 8.35 29.10 34.37 39.67 45.76 50.92
Stock % traded at NYSE/AMEX 50.77 7.71 40.57 46.00 51.50 56.29 50.77
Stock % included in S&P500 index 28.39 3.62 24.09 25.61 28.19 31.13 33.33
Stock % already included in previous month 50.77 7.71 40.57 46.00 51.50 56.29 60.30

Panel B: Time-Series Average of Cross-Sectional Distributions (159,902 Stock-Month Obs)

Jan 1996–Dec 2012 Mean Std 10-Pctl Q1 Med Q3 90-Pctl
Firm size in million 7,788 24,134 333 682 1,726 5,252 16,030
Firm size CSRP percentile (%) 81 15 60 72 84 93 97
Firm book-to-market CSRP percentile (%) 33 24 6 13 27 49 70
Firm volatility CSRP percentile (%) 50 22 20 33 51 68 81
Institutional ownership (%) 69 21 40 57 72 84 93
Analyst coverage 11.52 7.34 3.37 5.85 9.96 15.90 21.96

Panel C: Time-Series Average of Industry Distribution

Stocks with CRSP Stocks with CRSP
FF-12 Industry FF-12 Industry
options sample options sample
Consumer nondurables 4.19% 5.10% Telecom 3.85% 3.01%
Consumer durables 2.19% 2.32% Utilities 2.04% 2.48%
Manufacturing 9.20% 9.21% Wholesale 11.61% 10.36%
Energy 5.04% 3.50% Healthcare 12.94% 10.39%
Chemicals 2.18% 1.91% Finance 9.77% 19.68%
Business Equipment 23.48% 18.17% Others 13.52% 13.87%

55
 Table A2: Equity Returns Sorted on Equity Characteristics
The equity characteristics used to predict delta-hedged option returns are described in Table 1. At the end of each
month, we rank all stocks into deciles by equity characteristics and calculate both equal-weighted and value-
weighted stock returns. We calculate these returns for the sample of all CRSP stocks (common stocks with price
above $5 at the end of last month) and for a sample of stocks matched to the option sample. The table reports the
spread stock return that is long in the tenth decile and short in the first decile. All returns in this table are
expressed in percent. The sample period is from January 1996 to December 2012. To adjust for serial correlation,
robust Newey-West (1987) t-statistics are reported in brackets.

All Stocks: Matched Sample:

(10-1) Return Spread (10-1) Return Spread
Sign for
Sign for
return to
stock return EW VW EW VW
delta-neutral
in literature
call writing

Ln(ME) – – -0.20 -0.48 0.51* 0.34

(-0.71) (-1.44) (1.79) (1.09)
Ln(BM) – + 0.82* 0.22 0.41 0.07
(1.79) (0.68) (1.04) (0.18)
RET(-1,0) – – -0.56 -0.44 -0.04 0.04
(-1.42) (-1.21) (-0.12) (0.13)
RET(-12,-2) – + 1.30** 0.76 0.92** 1.20**
(2.39) (1.56) (2.16) (2.05)
ACC – – -0.24 -0.10 0.15 0.06
(-1.64) (-0.53) (1.06) (0.20)
AG – – -0.41* -0.29 0.05 -0.15
(-1.92) (-1.32) (0.28) (-0.42)
CH + + -0.01 0.51 -0.35 0.85**
(-0.02) (1.05) (-1.03) (2.10)
DISP + – -0.90** -0.40 -0.75*** -0.49
(-2.57) (-0.93) (-3.12) (-1.41)
ISSUE + + -1.03*** -0.57* -0.75** -0.38
(-2.95) (-1.79) (-2.55) (-1.16)
IVOL + – -1.03* -0.63 -0.72** -0.35
(-1.73) (-1.07) (-1.98) (-0.73)
PROFIT – + 0.64 0.40 0.90*** 0.73
(1.44) (1.25) (3.28) (1.64)
SUE – + 0.69*** 0.11 0.31** 0.10
(3.93) (0.78) (2.34) (0.35)

56
 Table A3: Return Spread to Daily Rebalanced and Compounded Delta-Neutral Call Writing
Sorted on Equity Characteristics
Equity characteristics used to predict delta-hedged option returns are described in Table 1. At the end of each
month, we rank all stocks with options traded into deciles (quintiles) by these equity characteristics. For each
stock, we sell one contract of call option against a long position of ∆ shares of the underlying stock, where ∆ is
the Black-Scholes call option delta. The delta-hedges are rebalanced daily. For each stock and in each month,
we compound the daily returns of the rebalanced delta-hedged call-option positions over the month to arrive at
the monthly return. We use three weighting schemes in computing the average return to delta-neutral call
writing for a portfolio of stocks: equal weight, weight by the market capitalization of the underlying stock, and
weight by the market value of option open interest at the beginning of the period. The table reports the spread
return that is long in the tenth decile (the fifth quintile) and short in the first decile (the first quintile). All returns
in this table are expressed in percent. The sample period is from January 1996 to December 2012. To adjust for
serial correlation, robust Newey-West (1987) t-statistics are reported in brackets.

(10-1) Return Spread (5-1) Return Spread

EW VW Option-VW EW VW Option-VW

Ln(ME) -2.47*** -1.95*** -3.07*** -1.94*** -1.43*** -2.84***

(-16.26) (-14.11) (-12.71) (-14.73) (-11.27) (-11.21)
Ln(BM) -0.07 0.02 0.29 -0.11 -0.08 -0.03
(-0.34) (0.14) (1.21) (-0.80) (-0.70) (-0.16)
RET(-1,0) -0.50*** -0.02 -0.31 -0.32*** 0.02 -0.11
(-3.53) (-0.13) (-1.43) (-3.02) (0.15) (-0.65)
RET(-12,-2) -1.37*** -0.74*** -1.15*** -1.07*** -0.46*** -0.83***
(-6.69) (-3.02) (-3.94) (-6.42) (-2.91) (-3.95)
ACC -0.08 -0.09 0.16 0.03 0.03 0.12
(-1.08) (-0.78) (0.78) (0.50) (0.34) (0.75)
AG -0.33*** 0.01 -0.47** -0.11 0.12 -0.20
(-3.97) (0.08) (-2.38) (-1.53) (1.14) (-1.33)
CH 1.35*** 0.52*** 1.08*** 0.94*** 0.24 0.52**
(8.48) (2.87) (4.17) (6.35) (1.33) (2.37)
DISP 1.25*** 0.57*** 1.32*** 1.11*** 0.40*** 1.08***
(10.70) (3.55) (5.71) (11.91) (3.06) (5.95)
ISSUE 0.75*** 0.03 0.54** 0.65*** 0.15 0.54***
(5.53) (0.30) (2.21) (5.21) (1.65) (3.05)
IVOL 2.20*** 1.30*** 2.21*** 1.69*** 0.93*** 1.85***
(12.66) (6.03) (7.74) (10.33) (4.41) (7.02)
PROFIT -1.68*** -0.81*** -2.01*** -1.16*** -0.42*** -1.22***
(-15.41) (-5.19) (-9.24) (-12.57) (-3.09) (-7.05)
SUE -0.17* 0.20 0.13 -0.10 0.14 0.22
(-1.93) (1.09) (0.60) (-1.49) (1.35) (1.42)

57
 Table A4: Return to Delta-Neutral Call Option Strategies Held until Maturity
Sorted on Equity Characteristics
Equity characteristics used to predict delta-hedged option returns are described in Table 1. At the end of each
month, we rank all stocks with options traded into deciles by the equity characteristics. For each stock, we sell
one contract of call option against a long position of ∆ shares of the underlying stock, where ∆ is the Black-
Scholes call option delta. We use three weighting schemes in computing the average return of buying delta-
hedged puts for a portfolio of stocks: equal weight (EW), weight by the market capitalization of the underlying
stock (VW), and weight by the market value of option open interest at the beginning of the period (Option-VW).
The table reports the spread return that is long in the tenth decile (the fifth quintile) and short in the first decile
(the first quintile). All returns in this table are expressed in percent. The sample period is from January 1996 to
December 2012. To adjust for serial correlation, robust Newey-West (1987) t-statistics are reported in brackets.

(10-1) Return Spread (5-1) Return Spread

EW VW Option-VW EW VW Option-VW

Ln(ME) -7.39*** -6.90*** -8.66*** -6.06*** -5.60*** -7.60***

(-22.88) (-20.11) (-14.91) (-23.67) (-21.87) (-15.45)
Ln(BM) -0.21 0.95*** 1.22** -0.43 0.78*** 0.71*
(-0.60) (2.87) (2.11) (-1.65) (3.39) (1.81)
RET(-1,0) -2.02*** -1.58*** -1.76*** -1.62*** -1.12*** -1.73***
(-4.83) (-3.48) (-2.93) (-4.90) (-3.61) (-4.18)
RET(-12,-2) -3.18*** -3.41*** -4.71*** -2.37*** -2.41*** -3.55***
(-6.70) (-5.82) (-6.08) (-6.14) (-5.03) (-5.68)
ACC -0.04 -0.11 0.46 0.26* -0.14 0.56
(-0.20) (-0.41) (0.98) (1.85) (-0.56) (1.47)
AG -0.76*** -0.88** -1.12** -0.09 -0.26 -0.55
(-3.45) (-2.57) (-2.21) (-0.48) (-1.14) (-1.40)
CH 3.67*** 0.38 2.64*** 2.96*** 0.68** 1.65***
(9.91) (0.76) (4.60) (9.44) (2.08) (3.67)
DISP 4.01*** 3.37*** 5.06*** 3.59*** 2.34*** 4.02***
(19.18) (11.01) (12.16) (20.60) (10.47) (13.12)
ISSUE 2.95*** 1.12*** 2.27*** 2.61*** 1.16*** 2.33***
(12.00) (3.82) (4.06) (12.44) (4.90) (5.56)
IVOL 7.28*** 5.94*** 7.40*** 6.04*** 4.57*** 6.19***
(22.57) (15.64) (13.61) (20.20) (14.05) (13.59)
PROFIT -4.81*** -3.72*** -5.68*** -3.74*** -2.65*** -4.26***
(-16.72) (-9.80) (-10.31) (-14.83) (-11.01) (-10.55)
SUE -0.19 -0.40 -0.25 -0.03 -0.07 0.04
(-1.18) (-1.21) (-0.63) (-0.20) (-0.33) (0.12)

58
 Table A5: Return of Delta-Neutral Put Option Strategies
Sorted on Equity Characteristics
Equity characteristics used to predict delta-hedged option returns are described in Table 1. At the end of each
month, we rank all stocks with options traded into deciles (quintiles) by equity characteristics. For each stock,
we buy one contract of put option hedged by a short position of ∆ shares of the underlying stock, where ∆ is the
Black-Scholes put option delta. The option position is held for one month without rebalancing delta-hedges. We
use three weighting schemes in computing the average return of buying delta-hedged puts for a portfolio of
stocks: equal weight (EW), weight by the market capitalization of the underlying stock (VW), and weight by the
market value of option open interest at the beginning of the period (Option-VW). The table reports the spread
return that is long in the tenth decile (the fifth quintile) and short in the first decile (the first quintile). All returns
in this table are expressed in percent. The sample period is from January 1996 to December 2012. To adjust for
serial correlation, robust Newey-West (1987) t-statistics are reported in brackets.

(10-1) Return Spread (5-1) Return Spread

EW VW Option-VW EW VW Option-VW

Ln(ME) 3.10*** 2.90*** 3.61*** 2.52*** 2.36*** 3.13***

(30.00) (23.66) (15.47) (29.72) (24.76) (12.79)
Ln(BM) 0.02 -0.41*** -0.79*** 0.14 -0.27** -0.34*
(0.15) (-3.05) (-3.38) (1.35) (-2.31) (-1.83)
RET(-1,0) 0.59*** 0.40*** -0.54*** 0.48*** 0.37*** -0.24
(5.51) (2.60) (-2.63) (6.08) (3.02) (-1.29)
RET(-12,-2) 1.10*** 0.83*** 1.18*** 0.80*** 0.59*** 0.85***
(6.64) (3.78) (4.03) (5.87) (3.49) (4.04)
ACC 0.11 0.11 -0.13 -0.04 -0.05 -0.17
(1.41) (0.90) (-0.64) (-0.68) (-0.50) (-1.24)
AG 0.28*** 0.29* 0.51** 0.02 0.19* 0.35**
(2.82) (1.77) (2.42) (0.26) (1.73) (2.17)
CH -1.52*** -0.11 -0.89*** -1.22*** -0.15 -0.48***
(-13.17) (-0.46) (-4.16) (-11.33) (-0.85) (-2.79)
DISP -1.59*** -1.25*** -1.80*** -1.46*** -0.92*** -1.59***
(-16.18) (-8.35) (-9.18) (-20.16) (-7.92) (-9.26)
ISSUE -1.21*** -0.52*** -0.60** -1.10*** -0.45*** -0.65***
(-11.39) (-4.26) (-2.37) (-13.59) (-4.23) (-3.37)
IVOL -3.17*** -2.48*** -3.35*** -2.54*** -1.89*** -2.62***
(-27.70) (-15.49) (-14.10) (-24.44) (-12.67) (-13.38)
PROFIT 1.83*** 1.49*** 1.89*** 1.42*** 1.08*** 1.52***
(17.12) (9.32) (7.91) (16.46) (9.17) (8.77)
SUE 0.16*** 0.13 -0.11 0.03 -0.01 -0.04
(3.00) (0.94) (-0.47) (0.58) (-0.17) (-0.22)

59
 Table A6: Controlling for the Impact of Idiosyncratic Volatility
This table reports the equal-weighted average returns of delta-neutral covered calls within each idiosyncratic
volatility (IVOL) quintile. Each month, we first sort optionable stocks into five quintiles (G1–G5) by IVOL.
Within each IVOL quintile, we then further sort by the other seven equity characteristics into five quintiles
(Q1–Q5). All of the numbers in this table are monthly portfolio returns expressed in percent. The sample
period is from January 1996 to December 2012. To adjust for serial correlation, robust Newey-West (1987) t-
statistics are reported in brackets.
Equal-Weighted (5-1) Return Spread within IVOL Quintiles
IVOL Quintiles Q1 Low 2 3 4 Q5 High (5-1) t-stat
Ln(ME) Quintiles
G1- Low 2.91 2.25 2.02 1.94 1.85 -1.06*** (-9.64)
2 3.80 3.17 2.69 2.50 2.23 -1.57*** (-10.65)
3 4.63 3.70 3.34 3.05 2.64 -1.99*** (-12.09)
4 5.50 4.29 3.94 3.63 3.13 -2.37*** (-12.23)
G5- Low 6.82 5.72 5.17 4.66 4.17 -2.65*** (-12.92)
RET(-1,0) Quintiles
G1- Low 2.54 2.25 2.12 2.05 2.05 -0.50*** (-6.79)
2 3.43 2.97 2.81 2.71 2.68 -0.76*** (-6.28)
3 4.06 3.63 3.39 3.20 3.29 -0.77*** (-6.47)
4 4.74 4.26 4.16 3.94 3.72 -1.02*** (-5.60)
G5- Low 6.42 5.52 5.13 4.87 5.01 -1.40*** (-6.85)
RET(-12,-2) Quintiles
G1- Low 2.43 2.25 2.08 2.12 2.13 -0.30*** (-3.49)
2 3.46 2.91 2.71 2.79 2.65 -0.81*** (-5.81)
3 4.18 3.66 3.37 3.15 3.15 -1.03*** (-6.42)
4 4.81 4.38 4.00 3.81 3.80 -1.02*** (-4.78)
G5- Low 6.43 5.42 4.93 5.01 4.99 -1.44*** (-6.64)
CH Quintiles
G1- Low 2.33 2.17 2.22 2.28 2.63 0.29*** (3.65)
2 2.91 2.89 2.94 3.12 3.45 0.54*** (4.34)
3 3.44 3.47 3.53 3.62 4.08 0.64*** (3.64)
4 3.83 4.06 3.97 4.28 4.90 1.07*** (6.94)
G5- Low 5.20 5.24 5.19 5.30 6.17 0.96*** (4.81)
DISP Quintiles
G1- Low 2.03 2.06 2.10 2.28 2.46 0.43*** (6.56)
2 2.60 2.66 2.79 3.06 3.27 0.67*** (7.13)
3 3.06 3.18 3.39 3.60 4.02 0.96*** (8.51)
4 3.53 3.65 3.93 4.42 4.82 1.29*** (10.48)
G5- Low 4.52 4.95 5.13 5.59 6.01 1.49*** (8.95)
ISSUE Quintiles
G1- Low 2.17 2.11 2.16 2.25 2.29 0.12* (1.76)
2 2.77 2.76 2.96 3.01 2.99 0.23*** (3.06)
3 3.25 3.47 3.53 3.51 3.69 0.44*** (4.46)
4 3.95 4.13 4.06 4.16 4.39 0.44*** (2.92)
G5- Low 5.00 5.36 5.30 5.38 5.80 0.79*** (3.85)
PROFIT Quintiles
G1- Low 2.45 2.26 2.15 2.00 2.10 -0.34*** (-5.49)
2 3.39 2.91 2.82 2.68 2.61 -0.77*** (-9.82)
3 4.16 3.60 3.30 3.20 3.05 -1.11*** (-11.57)
4 5.00 4.29 3.86 3.69 3.62 -1.38*** (-8.84)
G5- Low 6.47 5.39 4.96 4.88 4.81 -1.66*** (-10.43)

60