Options - Stock Returns during Option Expiration Weeks and the Option-Stock Volume Ratio.pdf

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Electronic copy available at: Stock Returns during Option Expiration Weeks and the Option-Stock Volume Ratio 1 Chris Stivers Terry College of Business University of Georgia Athens, GA 30602 Licheng Sun Department of Finance College of Business Old Dominion University Norfolk, VA 23529 This version: March 15, 2010 1 Comments welcome. Please address comments to Chris Stivers (e-mail:; phone: (706) 542-3648) or to Li
  Electronic copy available at: Stock Returns during Option Expiration Weeksand the Option-Stock Volume Ratio 1Chris StiversTerry College of BusinessUniversity of GeorgiaAthens, GA 30602Licheng SunDepartment of FinanceCollege of BusinessOld Dominion UniversityNorfolk, VA 23529This version: March 15, 2010 1 Comments welcome. Please address comments to Chris Stivers (e-mail:; phone:(706) 542-3648) or to Licheng Sun (e-mail:; phone: (757) 683-6552).  Electronic copy available at: Stock Returns during Option Expiration Weeks andthe Option-Stock Volume Ratio Abstract Over 1983 to 2008, we find that large-cap stocks with actively traded options tend to havesubstantially higher average weekly returns during option-expiration weeks (ending on a month’sthird-Friday), with consistent subperiod results. This empirical regularity is also evident in large-cap-dominated stock portfolios. Further, over the 1996 to 2008 period with available Option Metricsdata, we find that the average weekly stock returns for option-expiration weeks tend to be apprecia-bly larger for option-expiration weeks that also experience a relatively high option trading volume,relative to the underlying stock trading volume. In contrast, the average weekly returns for theoption-expiration week are not much different than other weeks for smaller-cap stock portfolios,which contain stocks with relatively less option trading activity. Further, for our sample of large-capstocks, the average weekly stock returns for the third-Friday of a calendar month are not differentthan other weeks for a pre-option-market sample over 1948 to 1972. We provide additional evidencethat, along with the option market evidence in Lakonishok, Lee, Pearson, and Poteshman (2007),suggests that the sizable written call activity from non-market makers may contribute towardsunderstanding our empirical findings.JEL Classification: G12, G13, G14Keywords: Option Expiration, Stock Returns, Option and Stock Trading Volume  Electronic copy available at: 1. Introduction The past three decades have experienced a dramatic growth in the size of the options market.According to the Chicago Board Options Exchange (CBOE), in 2007 CBOE options contractvolume reached an all-time record of 944,471,924 contracts. The growth rates in CBOE optionscontract volume were 33%, 44%, and 40% in 2005, 2006, and 2007 respectively. 1 Further, recentresearch indicates that option-related activity may have an influence on the underlying stock pricebehavior (Ni, Pearson, and Poteshman (2005)), or may contain information about the subsequentbehavior of stock prices (Roll, Schwartz, and Subrahmanyam (2010)). Ni, Pearson, and Poteshman(2005) document that the closing prices of optionable stocks tend to cluster at option strike priceson option-expiration days. They attribute the pricing patterns to hedge rebalancing by optionmarket makers and stock price manipulation by firm proprietary traders.Given the tremendous growth in option trading activities and this recent research, this paperre-examines the behavior of stock returns during option-expiration weeks. A few older studiesexamine stock returns around the expiration day with return horizons beyond the actual expirationday. Klemkosky (1978) analyzes weekly stock returns before and after option expiration for alimited sample of 14 expiration periods in 1975 and 1976. He finds that 12 of the 14 expirationweeks have negative returns (10 of the 14 weeks are significantly negative) with an average returnof about  − 1% in the expiration week. The returns in the week after option expiration are largelypositive with an average return of 0 . 4%. Using a longer sample from January 1979 to June 1985,Cinar and Vu (1987) examine the effect of option expiration on six large-cap stocks (IBM, GM,Eastman Kodak, 3M, Sears and Exxon). They find that the mean returns of these stocks duringthe expiration weeks are mostly statistically indistinguishable from zero. 2 Mayhew (2000) surveysthe empirical evidence on expiration-day effects and concludes that “although there appear to havebeen specific instances of price movements on expiration days that appear to have been related to 1 See the website 2 Other studies examine option-expiration effects on the expiration day or the end of the expiration day. Forexample, Stoll and Whaley (1987, 1991) look at expiration-day effects by focusing exclusively on the trading activityduring the last hour of trading on triple-witching days (days on which index futures, index options and options onindex futures expire simultaneously) and first half-hour of the following day. 1  traders unwinding their positions, there is little evidence of a strong, systematic price effect aroundexpiration.”With the huge growth in option trading activities in recent years and the much longer time-seriesnow available, these earlier studies seem both outdated and limited in their scope. In this article, were-examine stock returns over option-expiration weeks for both large individual stocks and variousstock indices. We focus on the weekly returns of large individual firms that have actively tradedoptions over the 1996 to 2008 period, corresponding to option-volume data availability from OptionMetrics. However, our study also examines a longer 1983 to 2008 period (with 1983 coinciding withthe introduction of stock index options) and a pre-option-market period over 1948 to 1972.This article is also the first to examine whether the relative trading activity in options has arole in understanding the return patterns during option expiration weeks. We follow from Roll,Schwartz, and Subrahmanyam (2010), hereafter RSS, and examine the ratio of option trading vol-ume to stock trading volume, or O/S. RSS study the time-series properties and cross-sectionaldeterminants of the O/S ratio. Their findings include that the O/S tends to be higher around earn-ings announcements and that the O/S ratio is positively related to the absolute post-announcementreturns.The intuition behind examining the O/S ratio is simple. If weekly returns appear to behavedifferently during the option-expiration week (in contrast to the other weeks) and the behavior istied to option-related activity, then it seems likely that the associated patterns would be strongerduring option-expiration weeks that experience a relative large O/S. Accordingly, we also separatelyexamine the mean and volatility of returns for option-expiration weeks that have a relatively highO/S value. 3 In stark contrast to earlier studies, we present striking new empirical evidence that averagestock returns tend to be higher during option-expiration weeks as compared to average returns inother weeks, at least for large-cap stocks with very active option trading. First, for our primarysample of 28 large-cap individual stocks with active option activity over 1996 to 2008, the average 3 We use a weekly O/S, defined as the average of the option trading volume for the five trading days concluding inthe last day of the calendar week (normally Friday) divided by the comparable average of stock trading volume overthe same five trading days. 2
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