Option Returns: Closing Prices Are Not What You Pay
63 Pages Posted: 4 Dec 2019
Date Written: November 18, 2019
We document that end-of-day equity and index options quoted bid-ask mid-points which are widely used to compute option returns, implied volatilities, and greeks, do not accurately represent trading prices for a day. Delta-hedged option returns computed using these mid-quotes are systematically higher compared to those using any other mid-quote during a day. These differences, which can reach up to 1% per day, are attributed to dynamics of option net order flows, and option market makers inventory position management. An introduction of night hours trading for SPX options allows for overnight inventory hedging and more flexible liquidity provision during day hours. Our results help explain such puzzles in the option literature as different non-trading and trading returns, or different day and night returns. Using earlier trading hour’s quotes removes differential pricing of equity vs. index options, or trading vs non-trading returns, as the returns across all contracts become similarly negative.
Suggested Citation: Suggested Citation