In Search of a Factor Model for Optionable Stocks

We propose the first factor model that explains cross-sectional variation in optionable stock returns. Our model includes new factors based on option-implied volatility minus realized volatility, the call minus put implied volatility spread, and the difference between changes in call and put implied volatilities, along with the market factor. The model outperforms previously-proposed factor models at explaining the performance of portfolios of optionable stocks formed by sorting on other option-based predictors, as well as other well-known stock return predictors. Our model provides a benchmark for assessing whether portfolios of optionable stocks generate returns that are not explained by previously-documented phenomena.