Are stock returns anomalous during option expiration weeks? In the March 2010 version of their paper entitled “Stock Returns during Option Expiration Weeks and the Option-Stock Volume Ratio”, Chris Stivers and Licheng Sun investigate the behavior of stock returns during option expiration weeks for both large individual stocks and various stock indexes, focusing on individual large-cap stocks with actively traded options during 1996-2008. They also examine a longer 1983-2008 period (commencing with the introduction of stock index options) and a 1948-1972 pre-option market period. Using weekly stock return/trading volume and option trading volume data as available over these periods, they conclude that:
- The average weekly return of 28 large-cap stocks with actively traded options during option expiration week (other weeks) is 0.45% (0.12%) over the period 1996-2008, with average weekly return volatility 4.97% (4.57%) and weekly Sharpe ratio 0.57 (0.07).
- This anomalous option expiration week performance for these 28 stocks is larger for weeks with relatively high option trading volume. For the 7.5% (92.5%) of weeks with the highest (lower) ratio of option volume to stock volume, the average weekly return of 28 large-cap stocks with actively traded options is 0.83% (0.14%) during option expiration week over the period 1996-2008, with average weekly return volatility 4.87% (4.64%) and weekly Sharpe ratio 1.25 (0.11).
- Results for these 28 stocks during two equal subperiods within 1996-2008 are consistent.
- The average option expiration week return for the same 28 large-cap stocks is also relatively high during 1983-1995. However, for the 15 of these 28 stocks with return histories available during a 1948-1972 pre-option market period, average return during the week of the third Friday is not unusually high.
- During 1983-2008, average option expiration week returns are relatively high for the S&P 500 Index and for large-cap stocks, but not for small-cap stocks. Before 1983, the average S&P 500 Index return during the week of the third Friday is not unusual.
- The average return for the 28 large-cap stocks during the week after option expiration (other non-expiration weeks) is -0.03% (0.18%) during 1996-2008, suggesting some reversal of option expiration week performance.
In summary, evidence indicates that investors may be able to exploit anomalously high returns during option expiration weeks for large capitalization stocks with high ratios of option trading volume to stock trading volume.
A reader commented:
“The option-stock trading volume ratio aspect of this study is unusable in practice for two reasons: (1) a trader does not know ex ante the ratio of option trading volume to stock trading volume for the current expiration week; and, (2) the authors determine the thresholds for high and low volume ratios based on the entire sample (which is not fully known at any point during the sample period). Backtesting based on information unknown to a trader in real time makes it untradable. Hence, your summary is a bit too optimistic; the only real ‘edge’ here is the plain option expiration week effect. Of course, the study is still valid for trying to understand what is happening in the market.”
Traders interested in trying to exploit the option-stock relative volume aspect may want to test: (1) daily trading volume data for large capitalization stocks and their options during the week before expiration and during expiration week; and, (2) a sliding window of historical volume data for deciding when the option-stock trading volume ratio is high.
