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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)
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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

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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.

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