Andy Fodor

Option Market Efficiency and Analyst Recommendations

This paper examines the information content in option markets surrounding analyst recommendation changes. The sample includes 6,119 recommendation changes for optionable stocks over the period January 1996 through December 2005. As expected, mean underlying asset returns are positive (negative) on days of recommendation upgrades (downgrades). However, volatility levels and shifts prior to recommendation changes explain a significant portion of underlying asset price responses. Ex-ante price and volatility responses in option markets are linked to increased jump uncertainty risk premia. Our findings suggest information in option markets leads analyst recommendation changes, implying revisions contain less information than previously thought. Copyright (c) 2010 Blackwell Publishing Ltd.

Do Hedge Funds Arbitrage Market Anomalies

We investigate whether hedge funds arbitrage market anomalies. We examine a seven-factor model including traditional Fama and French (1993) and Carhart (1997) factors and factors associated with the anomalies of earnings momentum, equity financing, and asset growth rates. We find the average hedge fund employs a strategy consistent with the asset growth rate anomaly factor and opposite to the equity financing factor. On a strategy specific basis, we find that many sectors of hedge funds successfully arbitrage the asset growth anomaly and a few successfully arbitrage the earnings momentum anomaly. We fail to find successful use of the equity financing anomaly. Seven-factor model alphas tend to be positive and significant, indicating funds generate substantial returns unrelated to the seven factors.

Inefficient pricing from holdover bias in NFL point spread markets

We identify inefficiency in the National Football League (NFL) gambling market indicative of sticky preferences by bettors. NFL teams that qualified for the playoffs in the prior season are favoured by too large a margin in the opening week of the following season. Bettors view these teams as superior though they win only 51.7% of opening week games against teams that failed to make the playoffs in the prior year. Against the point spread, teams that made the playoffs in the prior year win only 35.6% of opening week games played against teams that failed to make the playoffs in the prior year. Systematic betting based on this trend results in significant profitability over the 2004–2012 seasons with an average return over 22% per game. We posit this can be explained by gamblers’ tendencies to cling to perceptions of teams formed from observation in the prior season. This confirms research in more traditional markets, suggesting investors can be slow to update asset valuations.

Firm Specific Option Risk and Implications for Asset Pricing

This paper examines the benefits and costs of investing in firm specific options as an additional investment in a portfolio. We examine twelve option strategies and find that there is significant negative (positive) abnormal return to buying (selling) puts from January 1996 through July 2006. There is almost no additional benefit from going long any option, and some benefit from selling calls, dependent on the amount option leverage taken. Additionally, we find that the premiums from selling puts are not related to any specific firm characteristic, suggesting a pervasive premium for puts. Asset pricing tests that include market option return factors are unable to explain the returns to firm specific options. Tests on delta-hedged portfolios confirm that the gains to puts are related to idiosyncratic volatility and not market volatility. This is indicative an idiosyncratic volatility risk premium that is distinct from idiosyncratic price risk.

Team interdependence and turnover: evidence from the NFL

Purpose - – The purpose of this paper is to empirically investigate the interactive effect of turnover and task interdependence on performance in work teams. Based on pervious research, the authors contend that turnover will have a negative effect on team performance and this effect will be more pronounced as teams perform highly interdependent tasks. Design/methodology/approach - – Using longitudinal data from the National Football League (NFL), the authors empirically examine the effect of player turnover on NFL team performance (i.e. wins and losses in the subsequent year), and the difference in team performance based on the high/low task interdependence of the work team. Findings - – Findings suggest a negative impact of turnover on organizational performance, regardless of the interdependent nature of work team tasks. In addition, the negative influence of turnover is enhanced by the task interdependence within a team. Originality/value - – This is one of the few studies that examine task interdependence as a moderating variable of the turnover – team performance relationship. More specifically, by examining an industry with high team member turnover (i.e. The NFL), the findings from this study give practicing managers a guide as to which work teams managers should attempt to minimize turnover.

On the Demand for Portfolio Insurance

While insurers manage underwriting risk with various methods including reinsurance, insurers increasingly manage asset risk with options, futures, and other derivatives. Previous research shows that buyers of portfolio insurance pay considerably for downside protection. We add to this literature by providing the first evidence on the cost of portfolio insurance, the payoff to portfolio insurance, and the relative demand for portfolio insurance across VIX levels. We find that the demand for portfolio insurance is relatively high at low levels of VIX, suggesting purchasers demand more downside protection when this protection is cheap on an absolute basis (but expensive on a relative basis). We also provide the first evidence on the hedging behavior of specific investor classes, and show that the demand for portfolio insurance is driven by retail investors (individuals) who buy costly insurance from institutional investors. Results are consistent with other types of paradoxical insurance-buying behavior.

Call-Put Implied Volatility Spreads and Option Returns

Prior literature shows that implied volatility spreads between call and put options are positively related to future underlying stock returns. In this paper, however, we demonstrate that the volatility spreads are negatively related to future out-of-the-money call option returns. Using unique data on option volumes, we reconcile the two pieces of evidence by showing that option demand by sophisticated, firm investors drives the positive stock return predictability based on volatility spreads, while demand by less sophisticated, customer investors drives the negative call option return predictability. Overall, our evidence suggests that volatility spreads contain information about both firm fundamentals and option mispricing.

The Sensitivity of Findings of Expected Bookmaker Profitability

Levitt demonstrates that, contrary to conventional wisdom, sports books may not try to balance the money wagered on the sides of a game but instead exploit preferences of bettors in order to maximize expected profits. Levitt’s findings are based on unique data from a wagering contest of the 2002 National Football League (NFL) season. Reconsideration based on 2004-2010 data from a similar contest yields findings of a dramatically smaller increase in expected profitability from strategic line making. Additionally, the traditional underperformance of favorites in athletic wagering may have somewhat subsided, which would also imply reduced bookmaker profits compared to those Levitt reports.

The Value and Use of the IRA Recharacterization Option

The recharacterization option allows IRA owners who convert a traditional IRA into a Roth IRA to choose the better of Roth or traditional treatment (for tax purposes) after returns are known. The authors used option-pricing models to estimate the value of this option and examined strategies to maximize its value. Using a simulation that applies a simple recharacterization strategy over a long time horizon, the authors show its potential value in private wealth management.The recharacterization option is a right given to the IRA owner who converts a traditional IRA to a Roth. The owner may choose to have the IRA treated as a Roth (for tax purposes) if the portfolio increases sufficiently in value before taxes are paid in the next tax year, or to have the IRA “recharacterized” back to a traditional otherwise. This asymmetric tax treatment can create tax savings for the IRA owner. Now that income limits have been removed for Roth conversions, the recharacterization option should become a major planning tool for individual investors. This paper applies option pricing models to establish the value of the recharacterization option, and discusses strategies to maximize the value of this option. We show that a multiple-year and multiple-portfolio approach to using recharacterization options can create considerable value for an IRA owner. Finally, we simulate the results for an IRA owner using a simple recharacterization strategy over a long time horizon. The recharacterization option should find increased use in private wealth management. JEL classification: G11; G13; H31

Is There Money to Be Made Investing in Options? A Historical Perspective

This paper examines the historical performance of 12 portfolios that include S&P 100/500 index options. Each option portfolio is formed using options with different maturities and moneyness, while incorporating bid-ask spreads, transaction costs, and margin requirements. Raw and risk-adjusted returns of option portfolios are compared to a benchmark portfolio that is only long the underlying asset. This allows the marginal impact of including options in the portfolio to be examined. The analysis reveals that including options in the portfolio most often results in underperformance relative to the benchmark portfolio. However, a portfolio that incorporates written options can outperform the benchmark on a raw and risk-adjusted basis. This result is dependent on restricting option investment relative to the maximum allowable margin. While positive and significant risk-adjusted performance is observed for some option portfolios, greater risk tolerance relative to the long index benchmark portfolio is required.