Improving momentum strategies using residual returns and option‐implied information

This paper provides an alternative method for enhancing momentum profits by combining residual returns and option‐implied information. The results show that the main benefit of applying residual returns to construct momentum portfolios is generating stable returns. Additionally, the incorporation of...

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Bibliographic Details
Published in:The journal of futures markets 2019-04, Vol.39 (4), p.499-521
Main Author: Liu, Ming‐Yu
Format: Article
Language:English
Subjects:
Markets
momentum
Options trading
Portfolios
Profits
Rates of return
residual returns
underreaction/overreaction
Volatility
volatility spread/skew
Winners
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Summary:This paper provides an alternative method for enhancing momentum profits by combining residual returns and option‐implied information. The results show that the main benefit of applying residual returns to construct momentum portfolios is generating stable returns. Additionally, the incorporation of implied volatility (IV) spread or IV skew into a residual momentum portfolio is found to significantly raise profits, particularly during bad times and high‐sentiment periods. This is because IV spread and IV skew can dissociate winners/losers with a price underreaction from those with a price overreaction, which suggests that informed traders who perceive price underreactions/overreactions trade in option markets.
ISSN:0270-7314
1096-9934
DOI:10.1002/fut.21988