Abstract
This paper presents a robust new finding of a significant negative relation between equity option returns and the volatility-of-volatility (VOV). After controlling for numerous existing option and stock characteristics, the VOV effect remains significantly negative. It also survives many robustness checks. A conceptual model provided reveals the pricing mechanism behind the VOV effect. The high-low return spread on option portfolios sorted on VOV cannot be explained by standard risk factors, and survives double sorting using a variety of control variables.
•There is a significant negative relation between equity option returns and the volatility-of-volatility (VOV).•The VOV effect holds controlling for numerous existing option and stock characteristics.•A conceptual model reveals the pricing mechanism behind the VOV effect.•The high-low return spread on option portfolios sorted on VOV cannot be explained by standard risk factors.•The high-low return spread survives double sorting using a variety of control variables.