Maturity Driven Mispricing of Options

This paper documents that short-term options achieve significantly lower returns during months with 4 versus 5 weeks between expiration dates. The average return differential ranges from 16 to 29 basis points per week for delta-hedged portfolios, and from 101 to 187 basis points per week for straddles, over 1996-2017. Evidence based on earnings announcements and institutional holdings suggests that investor inattention to exact expiration date rather than underlying risk exposures or transaction costs can explain the mispricing. Market makers seem to adjust prices accordingly, and tend to over-trade mispriced options against less sophisticated investors.