Retail Clientele and Option Returns

Abstract

Does the retail clientele matter for option returns? By delta-hedging options and trading straddles, thus allowing a focus on volatility, this paper empirically shows that a higher retail trading proportion (RTP) is related to lower option returns. Long-short portfolios involving options on low and high RTP stocks generate significantly positive abnormal returns. The results suggest that retail investors speculate and pay a lottery premium on the expected future volatility, resulting in more expensive options with higher implied volatilities. This systematic deviation of option-implied volatility from realized volatility suggests retail clientele as a behavioral-based driving force of volatility risk premium.

Keywords: delta-hedged option returns, lottery premium, retail investors, speculation

JEL Classification: G10, G11, G14