Maturity Driven Mispricing of Options
51 Pages Posted: 29 Nov 2016 Last revised: 1 Dec 2017
Date Written: November 1, 2017
Options on US equities typically expire on the third Friday of each month, implying that either four or five weeks elapse between two consecutive expiration dates. We find that options that are held from one expiration date to the next achieve significantly lower returns when there are four weeks between expiration dates. The average difference in returns ranges from 0.12% per week for delta-hedged put portfolios to 0.89% for straddles. We find consistent results from an alternative price-based measure of mispricing. We perform multiple tests to examine the risk of our option portfolios and do not find any underlying risk patterns that can potentially explain our results. We therefore argue that mispricing that we identify is due to investor inattention to the exact expiration date, and provide further supporting evidence based on earnings announcements and price patterns closer to maturity. Our results survive a series of robustness tests and are unlikely to be driven by transaction costs. Overall, our evidence points to a potential strong behavioral bias among option traders.
Keywords: Option returns; Investor inattention
JEL Classification: G13, G14
Suggested Citation: Suggested Citation