Hostname: page-component-586b7cd67f-tf8b9 Total loading time: 0 Render date: 2024-11-29T09:50:07.377Z Has data issue: false hasContentIssue false
  • English
  • Français

Maturity Driven Mispricing of Options

Published online by Cambridge University Press:  19 January 2021

Assaf Eisdorfer ,
Ronnie Sadka Open the ORCID record for Ronnie Sadka [Opens in a new window]  and
Alexei Zhdanov
Assaf Eisdorfer
Affiliation:
The University of Connecticut School of [email protected]
Ronnie Sadka*
Affiliation:
Boston College Carroll School of Management
Alexei Zhdanov
Affiliation:
Pennsylvania State University Smeal College of [email protected]
*
[email protected] (corresponding author)
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper documents that short-term options achieve significantly lower returns during months with 4 versus 5 weeks between expiration dates. The average return differential ranges from 16 to 29 basis points per week for delta-hedged portfolios, and from 101 to 187 basis points per week for straddles, over 1996–2017. Evidence based on earnings announcements and institutional holdings suggests that investor inattention to exact expiration date rather than underlying risk exposures or transaction costs can explain the mispricing. Market makers seem to adjust prices accordingly, and tend to over-trade mispriced options against less sophisticated investors.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 57 , Issue 2 , March 2022 , pp. 514 - 542
Copyright
© The Author(s), 2021. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

We thank Paul Borochin, Kenneth Froot, Amit Goyal, Yaniv Grinstein, Christopher Jones, Ron Kaniel, Sophie Xiaoyan Ni (Western Finance Association discussant), Amir Rubin, Joel Vanden, and seminar participants at Interdisciplinary Center Herzliya, the University of Connecticut, and the 2018 Western Finance Association meeting for helpful comments.

References

Amihud, Y. “Illiquidity and Stock Returns: Cross-Section and Time-Series Effect.” Journal of Financial Markets, 5 (2002), 31–56.CrossRefGoogle Scholar
An, B. J.; Ang, A.; Bali, T. G.; and Cakici, N.. “The Joint Cross Section of Stocks and Options.” Journal of Finance, 69 (2014), 2279–2337.CrossRefGoogle Scholar
Bakshi, G., and Kapadia, N.. “Delta-Hedged Gains and the Negative Market Volatility Risk Premium.” Review of Financial Studies, 16 (2003), 527–566.CrossRefGoogle Scholar
Bakshi, G.; Kapadia, N.; and Madan, D.. “Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options.” Review of Financial Studies, 16 (2003), 101–143.CrossRefGoogle Scholar
Bali, T., and Hovakimian, A.. “Volatility Spreads and Expected Stock Returns.” Management Science, 55 (2009), 1797–1812.CrossRefGoogle Scholar
Ball, R., and Brown, P.. “An Empirical Evaluation of Accounting Number.” Journal of Accounting Research, 6 (1968), 159–178.CrossRefGoogle Scholar
Beaver, W. H. “The Information Content of Annual Earnings Announcements.” Journal of Accounting Research, 6 (1968), 67–92.CrossRefGoogle Scholar
Bernales, A.; Thanos, V.; and Voukelatos, N.. “Do Investors Follow the Herd in Option Markets?” Journal of Banking & Finance, 119 (2020), 104899.CrossRefGoogle Scholar
Black, F., and Scholes, M.. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 81 (1973), 637–654.CrossRefGoogle Scholar
Bollerslev, T.; Chou, R. Y.; and Kroner, K. F.. “ARCH Modeling in Finance: A Review of the Theory and Empirical Evidence.” Journal of Econometrics, 52 (1992), 5–59.CrossRefGoogle Scholar
Boyer, B., and Vorkink, K.. “Stock Options as Lotteries.” Journal of Finance, 69 (2014), 1485–1527.CrossRefGoogle Scholar
Brennan, M.; Chordia, T.; and Subrahmanyam, A.. “Alternative Factor Specifications, Security Characteristics, and the Cross-Section of Expected Stock Returns.” Journal of Financial Economics, 49 (1998), 345–373.CrossRefGoogle Scholar
Broadie, M.; Chernov, M.; and Johannes, M.. “Understanding Index Option Return.” Review of Financial Studies, 22 (2009), 4493–4529.CrossRefGoogle Scholar
Cao, J., and Han, B.. “Cross Section of Option Returns and Idiosyncratic Stock Volatility.” Journal of Financial Economics, 108 (2013), 231–249.CrossRefGoogle Scholar
Chakrabarty, B., and Moulton, P.. “Earnings Announcements and Attention Constraints: The Role of Market Design.” Journal of Accounting and Economics, 53 (2012), 612–634.CrossRefGoogle Scholar
Chang, B. Young; Christoffersen, P.; Jacobs, K.; and Vainberg, G.. “Option Implied Measures of Equity Risk.” Review of Finance, 16 (2012), 385–428.CrossRefGoogle Scholar
Chordia, T.; Kurov, A.; Muravyev, D.; and Subrahmanyam, A.. “Index Option Trading Activity and Market Returns.” Management Science, 67 (2021), 1758–1778.Google Scholar
Christoffersen, P.; Heston, S. L.; and Kris, J. “Capturing Option Anomalies with a Variance-Dependent Pricing Kernel.” Review of Financial Studies, 26 (2013), 1963–2006.CrossRefGoogle Scholar
Cohen, L., and Frazzini, A.. “Economic Links and Predictable Returns.” Journal of Finance, 63 (2008), 1977–2011.CrossRefGoogle Scholar
Cox, J.; Ross, S.; and Rubinstein, M.. “Option Pricing: A Simplified Approach.” Journal of Financial Economics, 7 (1979), 229–263.CrossRefGoogle Scholar
DellaVigna, S., and Pollet, J. M.. “Investor Inattention and Friday Earnings Announcements.” Journal of Finance, 74 (2009), 709–749.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Gao, C.; Xing, Y.; and Zhang, X.. “Anticipating Uncertainty: Straddles Around Earnings Announcements.” Journal of Financial and Quantitative Analysis, 53 (2018), 2587–2617.CrossRefGoogle Scholar
Geske, R.; Subrahmanyam, A.; and Zhou, Y.. “Capital Structure Effects on the Prices of Equity Call Options.” Journal of Financial Economics, 121 (2016), 231–253.CrossRefGoogle Scholar
Gilbert, T.; Kogan, S.; Lochstoer, L.; and Ozyildirim, A.. “Investor Inattention and the Market Impact of Summary Statistics.” Management Science, 58 (2012), 336–350.CrossRefGoogle Scholar
Goyal, A., and Saretto, A.. “Cross-Section of Option Returns and Volatility.” Journal of Financial Economics, 94 (2009), 310–326.CrossRefGoogle Scholar
Han, B. “Investor Sentiment and Option Prices.” Review of Financial Studies, 21 (2007), 387–414.CrossRefGoogle Scholar
Heston, S. “A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options.” Review of Financial Studies, 6 (1993), 327–343.CrossRefGoogle Scholar
Hirshleifer, D.; Lim, S.; and Teoh, S. H.. “Driven to Distraction: Extraneous Events and Underreaction to Earnings News.” Journal of Finance, 64 (2009), 2289–2325.CrossRefGoogle Scholar
Hirshleifer, D.; Myers, J. N.; Myers, L. A.; and Teoh, S. H.. “Do Individual Investors Cause Post-Earnings Announcement Drift? Direct Evidence from Personal Trades.” Accounting Review, 83 (2008), 1521–1550.CrossRefGoogle Scholar
Hong, H.; Torous, W.; and Valkanov, R.. “Do Industries Lead Stock Markets?” Journal of Financial Economics, 83 (2007), 367–396.CrossRefGoogle Scholar
Johnston, R.; Leone, A. J.; Ramnath, S.; and Yang, Y.. “14-Week Quarters.” Journal of Accounting and Economics, 53 (2012), 271–298.CrossRefGoogle Scholar
Jones, C., and Shemesh, J.. “Option Mispricing around Nontrading Periods.” Journal of Finance, 73 (2018), 861–900.CrossRefGoogle Scholar
Lakonishok, J.; Inmoo, L.; Pearson, N.; and Poteshman, A.. “Option Market Activity.” Review of Financial Studies, 20 (2007), 813–857.CrossRefGoogle Scholar
Mahani, R. S., and Poteshman, A. M.. “Overreaction to Stock Market News and Misevaluation of Stock Prices by Unsophisticated Investors: Evidence from the Option Market.” Journal of Empirical Finance, 15 (2008), 635–655.CrossRefGoogle Scholar
May, R. G. “The Influence of Quarterly Earnings Announcements on Investor Decisions as Reflected in Common Stock Price Changes.” Journal of Accounting Research, 9 (1971), 119–163.CrossRefGoogle Scholar
McNichols, M., and Manegold, J. G.. “The Effect of the Information Environment on the Relationship Between Financial Disclosure and Security Price Variability.” Journal of Accounting and Economics, 5 (1983), 49–74.CrossRefGoogle Scholar
Morse, D. “Price and Trading Volume Reaction Surrounding Earnings Announcements: A Closer Examination.” Journal of Accounting Research, 19 (1981), 374–383.CrossRefGoogle Scholar
Pan, J. “The Jump-Risk Premia Implicit in Options: Evidence from an Integrated Time-Series Study.” Journal of Financial Economics, 63 (2002), 3–50.CrossRefGoogle Scholar
Pan, J., and Poteshman, A. M.. “The Information in Option Volume for Future Stock Prices.” Review of Financial Studies, 19 (2006), 871–908.CrossRefGoogle Scholar
Patell, J. M., and Wolfson, M. A.. “The Ex Ante and Ex Post Price Effects of Quarterly Earnings Announcements Reflected in Option and Stock Prices.” Journal of Accounting Research, 19 (1981), 434–458.CrossRefGoogle Scholar
Patell, J. M., and Wolfson, M. A.. “The Intraday Speed of Adjustment of Stock Prices to Earnings and Dividend Announcements.” Journal of Financial Economics, 13 (1984), 223–252.CrossRefGoogle Scholar
Poteshman, A. M. “Underreaction, Overreaction, and Increasing Misreaction to Information in the Options Market.” Journal of Finance, 56 (2001), 851–76.CrossRefGoogle Scholar
Poteshman, A. M., and Serbin, V.. “Clearly Irrational Financial Market Behavior: Evidence from the Early Exercise of Exchange Traded Stock Options.” Journal of Finance, 58 (2003), 37–70.CrossRefGoogle Scholar
Xing, Y.; Zhang, X.; and Zhao, R.. “What Does the Individual Option Volatility Smirk Tell Us about Future Equity Returns?” Journal of Financial and Quantitative Analysis, 45 (2010), 641–662.CrossRefGoogle Scholar