The Term Structure of Index Option Returns

Guanglian Hu is a Senior Lecturer in Finance and the Deputy Head of the Discipline of Finance (Research) at the University of Sydney Business School. His research focuses on asset pricing and derivatives. Topics include determinants of expected option returns, variance risk premium, VIX derivatives, consumption-based asset pricing, and stochastic discount factor. He has published his research in leading journals such as the Journal of Financial and Quantitative Analysis and the Review of Asset Pricing Studies. Before joining the University of Sydney, Hu worked as a Visiting Assistant Professor of Finance at ITAM and Pacific Lutheran University, where he taught courses in the undergraduate and graduate programs. He received his B.S. in Economics from Xiamen University in 2009, his M.A. in Economics from the University of California at Santa Barbara in 2010 and his Ph.D. in Finance from the University of Houston in 2017.

We compare the term structure of realized index option returns with those implied from option pricing models. While the stochastic volatility risk premium matches one-month option returns well, it cannot fit the returns of long maturity options. The volatility jump risk premium also struggles to fit the term structure of option returns. The price jump risk premium is sufficient to explain the patterns in realized option returns, but its success critically relies on the pricing of jump size variance. Finally, we present novel results on higher moments and Sharpe ratios of index option returns and on conditional expected option returns.