Risk Neutral Skewness (RNS) is regarded as a measurement of downside risk of underlying asset obtained from the option investors. Several pieces of literature focus on the forecasting power of RNS of individual equity options on future underlying stock returns. However, an inconsistent view exists toward the relationship between RNS and future underlying returns. Previous literature focuses on investigating the RNS of stock price, but little literature focuses on RNS on index level, especially European options. In this study, the relationship between the RNS of the FTSE 100 index and the future FTSE 100 index returns is examined. This study followed the method provided by Chordia, Lin, and Xiang (2021) to examine the effect of RNS on subsequent index returns and followed Wang and Yen (2022) to separate the derivatives contracts into bullish contracts and bearish contracts to test whether specific option contracts contain more information. This paper finds out that the bearish RNS from options maturing in 2 months exhibits a noteworthy negative relationship with FTSE 100 returns, suggesting the hedging demand based on investor skewness preferences in the short term. While RNSs in 3-, 4-, or 5- horizons show no significance, it suggests that the longer-term RNS might be indifferent to the investors.

Table of Contents
Chapter 1: Introduction-----1
Chapter 2: Literature Review-----3
2.1 Market Inefficiency and Private Information in Option Trading Activities-----3
2.2 Investors’ Preference on Asset Skewness-----4
2.3 The predictability of RNS on future returns-----6
2.4 The Different Characteristics of the American Option and European Option-----12
2.5 There are few papers focusing on index-level RNS-----12
2.6 RND of FTSE 100 index-----13
Chapter 3: Data & Methodology-----15
Data Sources-----15
Methodology-----17
3.1 Identify the bullish contracts and bearish contracts-----18
3.2 Calculate Risk Neutral Skewness and Risk Neutral Kurtosis-----20
3.3 Time to Maturity Calculation-----21
3.4 Calculate the relationship between skewness and return-----23
Chapter 4: Empirical Results-----25
RNS in 1-month horizon-----30
RNS in 2-month horizon-----31
The possible explanation of negative RNS-return relationship-----31
The possible explanation of the findings of bullish RNS and the bearish RNS-----33
The RNSs in 3-, 4-, and 5-month horizons-----34
Chapter 5: Conclusions-----36
References-----40
Appendix-----43

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