Investor Attention and Option Returns

Abstract

This paper examines the attention effect in the options market. We show that option investors (especially retail investors) buy more calls and puts on both daily winner and loser stocks, and this buying pressure leads to an overvaluation as shown in subsequent lower hedged returns. The overvaluation is due to a combination of differences of opinion, risk-aversion, and margin requirements. The economic magnitude is large. For instance, a zero-financing portfolio involving options on loser stocks renders an alpha of 2.90% per month. Aside from contributing to the broad literature of investor attention versus asset returns, our study also sheds light on an important yet largely neglected topic: the impact of margins on option trading and pricing.

Keywords: Investor attention, daily winners and losers, salience, overpricing, option returns

JEL Classification: G14