Equity Volatility Term Structures and the Cross-Section of Option Returns

The slope of the implied volatility term structure is positively related with future option returns. We rank firms based on the slope of the volatility term structure and analyze the returns for five different option trading strategies. Option portfolios with high slopes of the volatility term structure outperform option portfolios with low slopes by an economically and statistically significant amount. The results are robust to different empirical setups and are not explained by well-known market, size, book-to-market, or momentum factors. Additional higher-order option-related factors, volatility risk remiums, jump risk, and existing option anomalies cannot explain the large option returns.