The effect of option-implied skewness on delta- and vega-hedged option returns

We study the relation between option-implied skewness (IS) and the cross-section of option returns under daily hedging to better understand the pricing of skewness in isolation from lower moments. Creating portfolios of delta-hedged (D-hedged) and delta-vega-hedged (DV-hedged) options with daily rebalancing, we find that IS is negatively related to both D-hedged and DV-hedged call option returns, but has no significant relation to hedged put option returns. The negative relation observed is stronger when the underlying stock has a larger market beta and when the firm is more opaque. Our results suggest that investors’ skewness preference grows stronger with greater market risk and lower information quality. •We re-visit the relation between option-implied skewness and equity option returns.•We construct daily-rebalanced delta- and delta-vega-hedged option portfolios.•A salient negative relation between IS and equity option returns is in call samples.•The negative relation in put samples becomes insignificant under daily rebalancing.•Skewness changes in the right side of the distribution drive the finding.•The finding emphasizes the importance of hedging error in isolating skewness exposure.•Holding periods and the moneyness of options determine the IS portfolio returns.•Betting against beta and information asymmetry could partially explain the finding.