Option-implied skewness: Insights from ITM-options

Hannes Mohrschladt; Judith C. Schneider

doi:10.1016/j.jedc.2021.104227

Option-implied skewness: Insights from ITM-options

Hannes Mohrschladt^*
, Judith C. Schneider^*

^*Corresponding author for this work

Research output: Journal contributions › Journal articles › Research › peer-review

1 Citation (Scopus)

Abstract

While the standard to calculate model-free option-implied skewness (MFIS) relies on out-of-the-money (OTM) options, we examine the empirical and economic implications of using in-the-money (ITM) options. We find that the positive short-term return predictability of OTM-based MFIS significantly reverses if ITM-options are used instead. While this reversal is inconsistent with an explanation based on skewness preferences, MFIS apparently reflects information that is not timely incorporated in stock prices due to market frictions. Based on these insights, we introduce ΔMFIS as a new measure of additional option-embedded information that significantly predicts subsequent returns beyond a large range of other option-based return predictors.

Original language	English
Article number	104227
Journal	Journal of Economic Dynamics and Control
Volume	131
ISSN	0165-1889
DOIs	https://doi.org/10.1016/j.jedc.2021.104227
Publication status	Published - 01.10.2021
Externally published	Yes

Bibliographical note

This project was initiated when Judith C. Schneider was visiting researcher at INSEAD, Fontainebleau and was partly written while Hannes Mohrschladt was visiting researcher at the Ohio State University, Columbus. Financial support from the German Research Foundation (DFG) is gratefully acknowledged (DFG Grant SCHN 1454/2-1). The authors thank Maren Baars, Nicole Branger, Thomas Langer, Christian Schlag, two anonymous referees, participants at the 26th Annual Meeting of the German Finance Association, the 7th Paris Financial Management Conference, and the Finance Center Münster Research Seminar for their valuable comments. Further declarations of interest: none.

Research areas and keywords

In-the-money-options
Market frictions
Option-implied skewness
Return predictability
Management studies

ASJC Scopus Subject Areas

Applied Mathematics
Control and Optimization
Economics and Econometrics

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10.1016/j.jedc.2021.104227

Cite this

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title = "Option-implied skewness: Insights from ITM-options",

abstract = "While the standard to calculate model-free option-implied skewness (MFIS) relies on out-of-the-money (OTM) options, we examine the empirical and economic implications of using in-the-money (ITM) options. We find that the positive short-term return predictability of OTM-based MFIS significantly reverses if ITM-options are used instead. While this reversal is inconsistent with an explanation based on skewness preferences, MFIS apparently reflects information that is not timely incorporated in stock prices due to market frictions. Based on these insights, we introduce ΔMFIS as a new measure of additional option-embedded information that significantly predicts subsequent returns beyond a large range of other option-based return predictors.",

keywords = "In-the-money-options, Market frictions, Option-implied skewness, Return predictability, Management studies",

author = "Hannes Mohrschladt and Schneider, \{Judith C.\}",

note = "This project was initiated when Judith C. Schneider was visiting researcher at INSEAD, Fontainebleau and was partly written while Hannes Mohrschladt was visiting researcher at the Ohio State University, Columbus. Financial support from the German Research Foundation (DFG) is gratefully acknowledged (DFG Grant SCHN 1454/2-1). The authors thank Maren Baars, Nicole Branger, Thomas Langer, Christian Schlag, two anonymous referees, participants at the 26th Annual Meeting of the German Finance Association, the 7th Paris Financial Management Conference, and the Finance Center M{\"u}nster Research Seminar for their valuable comments. Further declarations of interest: none. ",

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doi = "10.1016/j.jedc.2021.104227",

language = "English",

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AU - Mohrschladt, Hannes

AU - Schneider, Judith C.

N1 - This project was initiated when Judith C. Schneider was visiting researcher at INSEAD, Fontainebleau and was partly written while Hannes Mohrschladt was visiting researcher at the Ohio State University, Columbus. Financial support from the German Research Foundation (DFG) is gratefully acknowledged (DFG Grant SCHN 1454/2-1). The authors thank Maren Baars, Nicole Branger, Thomas Langer, Christian Schlag, two anonymous referees, participants at the 26th Annual Meeting of the German Finance Association, the 7th Paris Financial Management Conference, and the Finance Center Münster Research Seminar for their valuable comments. Further declarations of interest: none.

PY - 2021/10/1

Y1 - 2021/10/1

N2 - While the standard to calculate model-free option-implied skewness (MFIS) relies on out-of-the-money (OTM) options, we examine the empirical and economic implications of using in-the-money (ITM) options. We find that the positive short-term return predictability of OTM-based MFIS significantly reverses if ITM-options are used instead. While this reversal is inconsistent with an explanation based on skewness preferences, MFIS apparently reflects information that is not timely incorporated in stock prices due to market frictions. Based on these insights, we introduce ΔMFIS as a new measure of additional option-embedded information that significantly predicts subsequent returns beyond a large range of other option-based return predictors.

AB - While the standard to calculate model-free option-implied skewness (MFIS) relies on out-of-the-money (OTM) options, we examine the empirical and economic implications of using in-the-money (ITM) options. We find that the positive short-term return predictability of OTM-based MFIS significantly reverses if ITM-options are used instead. While this reversal is inconsistent with an explanation based on skewness preferences, MFIS apparently reflects information that is not timely incorporated in stock prices due to market frictions. Based on these insights, we introduce ΔMFIS as a new measure of additional option-embedded information that significantly predicts subsequent returns beyond a large range of other option-based return predictors.

KW - In-the-money-options

KW - Market frictions

KW - Option-implied skewness

KW - Return predictability

KW - Management studies

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DO - 10.1016/j.jedc.2021.104227

M3 - Journal articles

AN - SCOPUS:85114266874

SN - 0165-1889

VL - 131

JO - Journal of Economic Dynamics and Control

JF - Journal of Economic Dynamics and Control

M1 - 104227

ER -

Option-implied skewness: Insights from ITM-options

Abstract

Bibliographical note

Research areas and keywords

ASJC Scopus Subject Areas

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