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Cheap Options Are Expensive

Author

Listed:
  • Assaf Eisdorfer

    (University of Connecticut - Department of Finance)

  • Amit Goyal

    (University of Lausanne; Swiss Finance Institute)

  • Alexei Zhdanov

    (Pennsylvania State University)

Abstract

We show that options written on stocks with low prices are over-priced. This effect is robust to a variety of tests, controlling for common stock- and option- risk characteristics, and to reasonable transaction costs. Natural experiments corroborate this finding; options tend to become relatively more expensive following stock splits; and options on mini-indices are overpriced relative to options written on otherwise identical regular-priced indices. Our evidence suggests that (less sophisticated) retail investors consider options with low underlying prices as good deals due to low prices of such options. Demand pressure from these investors leads to option overpricing.

Suggested Citation

  • Assaf Eisdorfer & Amit Goyal & Alexei Zhdanov, 2020. "Cheap Options Are Expensive," Swiss Finance Institute Research Paper Series 20-64, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2064
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    File URL: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3607030
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    Cited by:

    1. Bali, Turan G. & Beckmeyer, Heiner & Moerke, Mathis & Weigert, Florian, 2021. "Option return predictability with machine learning and big data," CFR Working Papers 21-08, University of Cologne, Centre for Financial Research (CFR).

    More about this item

    Keywords

    Option Returns; Investor Inattention;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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