February 28, 2018
This paper studies the effects of default risk on equity option returns. We examine the cross section of delta-hedged equity option returns for Optionmetrics stock for the period January 1996 to April 2016. We find that options on stocks with high default risk earn significantly lower returns than options on low default risk stocks. The high minus low return spreads for quintile and decile option portfolios sorted by credit rating or default probability range from -1.