Why Do Option Returns Change Sign from Day to Night?

Abstract

Average returns for S&P 500 index options are negative and large: -0.7% per day. Strikingly, when we decompose these delta-hedged option returns into intraday (open-to-close) and overnight (close-to-open) components, we find that average overnight returns are -1%, but intraday returns are actually positive, 0.3% per day. A similar return pattern holds for all maturity and moneyness categories and equity options. Most of the potential explanations struggle to explain positive intraday returns. However, our results are consistent with option prices’ failing to account for the well-known fact that stock volatility is substantially higher intraday than overnight. These findings help us better understand price formation in the options market.

Keywords: Option returns, seasonality, behavioral finance

JEL Classification: G14, G13