Common Risk Factors in Cross-Sectional FX Options Returns

We identify a comprehensive list of thirty-eight characteristics for predicting cross-sectional FX options returns. We find that three factors - long-term straddle momentum, implied volatility, and illiquidity - can generate economically and statistically significant risk premia not explained by other return predictors. Meanwhile, the predictability of the other characteristics becomes insignificant after accounting for the FX option three-factor model. The significance of the three factors is confirmed through a series of robustness tests covering different data sources, alternative options strategies, diversification effects, bootstrapping, and omitting crisis years.