On the 7/12 tastytrade Market Measures segment on “Get Tasted,” research tackled the question of whether the risk premium attached to the options of individual stocks is justified. Tom Sosnoff, tastytrade CEO and host of the Get Tasted program, described risk premium as the higher volatility that the options of individual stocks have in comparison to the volatility of the sector or overall market.
Using two years of data in home builder stocks, results indicate that the risk premium is not necessarily justified.
“We structured a test to see if the range predicted by the higher volatility for the individual stock – in this case KBH — was more accurate than the range predicted by the volatility of the home builder sector,” said Tom Preston, of tastytrade’s research team. “We estimated the range with the two sets of volatility data, and found that the sector volatility came closer to predicting the future price movement of KBH than KBH’s own higher volatility. The risk premium associated with KBH did not result in larger price swings in the stock price than the sector volatility would indicate.”
“This is the first time this type of information has ever been described to retail investors,” said Sosnoff. “That the options of higher volatility stocks might be overvalued relative to their sector means investors can get potentially higher rates of return for a given level of risk. tastytrade shows again why our content is changing the way America thinks about finance.”
This Market Measure segment is available at www.tastytrade.com.