It is diffffcult to understand the risk-return trade-off in option market with observable factormodels. In this paper, we employ a latent factor model for delta-hedge option returns over a varietyof important exchange traded options in China, based on the instrumented principal componentanalysis (IPCA). This model incorporates conditional betas instrumented by option characteristics,to tackle the diffffculty caused by short lifespans and rapidly migrating characteristics of options. Ourresults show that a three-factor IPCA model can explain 19.30% variance in returns of individualoptions and 99.23% for managed portfolios. An asset pricing test with bootstrap shows that there isno unexplained alpha term with such a model. Comparison with observable factor model indicatesthe necessity of including characteristics. We also provide subsample analysis and characteristicimportance.