Stock Option Returns and Stock Anomalies : Cross Market Efficiency and the Cost of Hedging Value vs Growth Firms Stock Returns

Abstract

The empirical literature on stock returns shows overwhelming evidence of stock anomalies related to value investing. This paper studies the relative performance of stock options of value and growth stocks. This yields insight into different strategies in attempting to hedge some of these types of stocks.Monthly option returns are examined from 1995 to 2004. The returns of calls and puts are analyzed with a corresponding discussion of other strategies directly linked to these results. In particular, evidence is found that the option returns on some growth stocks and the option returns on some value stocks outperform the average option return for puts deep out of the money. For puts deep in the money, buying puts for the most extreme decile of value stocks is significantly less expensive than other deciles. For value stocks deep out of the money call options had significantly higher returns (20%) than growth stocks(negative option returns). For both puts and calls across the value and growth deciles, writing options had higher returns than buying options. Strategies with profitable returns over the decade included bear spreads using calls on value stocks and bull spreads on value stocks and growth stocks (but not the highest decile for growth). A third strategy that was profitable for the decade included buying deep out of the money puts for deciles 2, 3 (growth) and 10 (value). The relative cost of hedging stocks in the options markets does depend on value vs. growth characteristics

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