The Derivative Payoff Bias

71 Pages Posted: 20 Sep 2023 Last revised: 30 May 2024

See all articles by Guido Baltussen

Guido Baltussen

Erasmus University Rotterdam (EUR); Northern Trust Corporation - Northern Trust Asset Management

Julian Terstegge

Copenhagen Business School

Paul Whelan

The Chinese University of Hong Kong

Date Written: September 6, 2023

Abstract

A significant fraction of U.S. equity index derivatives expire "a.m." on the 3rd Friday of each month via constituent stocks' opening trade price. We show these prices are biased upwards since the advent of overnight trading in the early 2000s. Equity prices drift up from Thursday close to 3rd Friday open and revert at the point derivative payoffs are calculated. As a result, equity futures and call option payoffs are biased upwards, while put option payoffs are biased downwards, generating a wealth transfer of ~$3.5 billion per year in S&P 500 index options alone. Exploring explanations, we show that a novel channel ("charm'') originating from market makers' hedging practices represents a plausible explanation for the derivative payoff bias.

Keywords: Stocks, Derivatives, Futures, Market Microstructure, Market Design

JEL Classification: G10, G12, G13, G14

Suggested Citation

Baltussen, Guido and Terstegge, Julian and Whelan, Paul, The Derivative Payoff Bias (September 6, 2023). Available at SSRN: https://ssrn.com/abstract=4562800 or http://dx.doi.org/10.2139/ssrn.4562800

Guido Baltussen

Erasmus University Rotterdam (EUR) ( email )

Burgemeester Oudlaan 50
3000 DR Rotterdam, Zuid-Holland 3062PA
Netherlands

Northern Trust Corporation - Northern Trust Asset Management ( email )

50 South LaSalle Street
Chicago, IL 60603
United States

Julian Terstegge

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Paul Whelan (Contact Author)

The Chinese University of Hong Kong ( email )

The Chinese University of Hong Kong
Finance Department
Copenhagen, DC 1854
Hong Kong

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
1,873
Abstract Views
5,736
Rank
19,396
PlumX Metrics