TY - JOUR

T1 - Option-implied skewness: Insights from ITM-options

AU - Mohrschladt, Hannes

AU - Schneider, Judith C.

N1 - Funding Information: 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

Y1 - 2021/10

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

UR - http://www.scopus.com/inward/record.url?scp=85114266874&partnerID=8YFLogxK

U2 - 10.1016/j.jedc.2021.104227

DO - 10.1016/j.jedc.2021.104227

M3 - Article

AN - SCOPUS:85114266874

VL - 131

JO - Journal of Economic Dynamics and Control

JF - Journal of Economic Dynamics and Control

SN - 0165-1889

M1 - 104227

ER -