Option-Implied Spreads and Option Risk Premia

Christopher L. Culp; Mihir Gandhi; Yoshio Nozawa; Pietro Veronesi

doi:10.3386/w28941

Option-Implied Spreads and Option Risk Premia

Christopher L. Culp, Mihir Gandhi, Yoshio Nozawa & Pietro Veronesi

Working Paper 28941

DOI 10.3386/w28941

Issue Date June 2021

We propose implied spreads (IS) and normalized implied spreads (NIS) as simple measures to characterize option prices. IS is the credit spread of an option’s implied bond, the portfolio long a risk-free bond and short a put option. NIS normalizes IS by the risk-neutral default probability and reflects tail risk. IS and NIS are countercyclical and predict implied bond returns, while neither, like implied volatility, predicts put returns. These opposite predictability results are consistent with a stochastic volatility, stochastic jump intensity model, as put premia increase in volatility but decrease in jump intensity, while implied bond premia increase in both.

For their comments, we thank Gerardo Manzo, Dmitriy Muravyev, and seminar participants at Bocconi University, Leeds School of Business, University of Chicago, and the 2019 AFA meetings. Veronesi acknowledges financial support from the Fama-Miller Center for Research in Finance and the Center for Research in Security Prices at the University of Chicago Booth School of Business. The views expressed here are those of the authors and do not necessarily reflect the views of any institution with which the authors are affiliated. Culp passed away in June 2020. We dedicate this paper to his memory. He was a wonderful coauthor, colleague, and friend. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
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Option-Implied Spreads and Option Risk Premia

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