Determinants of S&P 500 index option returns

We analyze common factors that affect returns on S&P 500 index options and find that 93% of the variation in option returns can be explained by three factors, which respectively account for 87%, 4%, and 2% of the variation in option returns. Furthermore, we test diffusion option pricing models by using mean-variance spanning properties implied in the models. The spanning tests reject one-factor diffusion models, as well as the hypothesis that the underlying asset and an equally weighted option index span options. Our results fail to reject that the underlying asset and an at-the-money option can span out-of-the-money options, but does reject that they span in-the-money options.