Thursday, April 24, 2025

Volatility Risk Premium Seasonality Across Calendar Months

Seasonality in investing refers to the tendency of financial markets or specific assets to exhibit predictable patterns at certain times of the year. These patterns can arise due to recurring economic, behavioral, or institutional factors. Understanding and analyzing seasonal trends can help investors time their trades more effectively and enhance portfolio performance.

We have recently discussed the seasonality of the volatility risk premium (VRP) in terms of days of the week. In this regard, Reference [1] examined the VRP in terms of months of the year. The authors pointed out,

As the first in the literature, this study documents a statistically significant December effect, namely, the delta-hedged returns in December are substantially lower than those in other months of the year. The lower hedged returns in December are attributed to overvaluation of options at the beginning of the month, which in turn is attributed to option investors’ consistent failure of recognizing and incorporating the lower realized volatility in the second half of December, i.e., the implied volatility at the beginning of December is consistently larger than the realized volatility in December. This December effect prevails in both equity options and S&P 500 index options. A trading strategy selling straddles based on the decile with the biggest predicted difference between implied volatilities and realized volatilities can generate a monthly return of 13.09% in December, compared with the unconditional sample mean of 0.88%. The next step of the study is to examine and rule out alternative channels such as time-varying risks and demand pressure.

In short, the authors concluded that the VRP is greatest in December and smallest in October.

An explanation for the large VRP in December is that during the holiday season, firms might refrain from releasing material information, leading to low trading volumes. The combination of low trading volume and the absence of important news releases would naturally result in lower realized volatility.

This is another important contribution to the understanding of the VRP. Let us know what you think in the comments below or in the discussion forum.

References

[1] Wei, Jason and Choy, Siu Kai and Zhang, Huiping, December Effect in Option Returns (2025). https://ift.tt/75k1LRn

Article Source Here: Volatility Risk Premium Seasonality Across Calendar Months



source https://harbourfronts.com/volatility-risk-premium-seasonality-across-calendar-months/

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