Abstract
We construct portfolios of S&P500 futures and their associated options, which are Delta (price) and Vega (volatility) neutral. These systematically earn negative abnormal returns, and suggest that out of the money puts are too expensive, relative to out of the money calls. We give evidence that these negative returns are not a payment for insurance against a market crash. We then do a factor analysis on the Delta hedged option price innovations. Including a 'smirk' factor, there is no evidence of arbitrage opportunities. However, the smirk seems unable to predict the skew in the underlying return, though it is useful for hedging portfolios of options. We finally conclude that the smirk represents the risk premium of a dynamic aversion to market falls, which seems unrelated to the underlying futures index.
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