Why Are Put Options So Expensive?
Read the paperopens papers.ssrn.com in a new tab
What they found
Bondarenko documented that S&P 500 futures put options from 1987 to 2000 lost about 39% per month on average for at-the-money puts and nearly all their value for deep out-of-the-money puts, and then asked whether any rational model could explain this. He showed that the put returns are too negative to be reconciled with a wide class of models, even ones allowing for the Peso problem (a crash that could have happened but did not), and concluded that puts were mispriced or that investors' crash fears were extreme.
What you can use
- Out-of-the-money index puts have lost almost all their value in most months; buying them regularly has been a wealth-destroying hedge.
- The overpricing is larger than crash risk alone can justify, which suggests persistent demand for insurance from investors who overweight tail scenarios.
- If you sell puts, know that you are being paid a premium partly because others are willing to overpay for protection, and partly because crashes do happen.
Caveats
Sample ends in 2000 and excludes 2008; put buyers were paid handsomely in the crisis. Working paper on SSRN with a later journal version.
Tags: options, puts, option-returns, crash-risk
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.