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Are there any systematic, marketwide return or volatility patterns associated with the expiration of U.S. stock options on the third Friday of each month? Using equity option expiration dates and daily closes for the S&P 500 index for 1/2/90-12/24/07, we find that:
The following chart shows the average daily S&P 500 index returns from five trading days before (OE-5) through five trading days after (OE+5) the 215 options expiration (OE) days during 1/2/90-12/24/07, with one standard deviation error bars. The mean daily return for all trading days (all Fridays) in the sample is 0.04% (0.01%). Results on average suggest a little abnormal strength before and a little weakness just after OE days. As usual for daily data, noise generally dominates signal.
Contrary to conventional wisdom, daily volatility is not unusual during this interval. The standard deviation of daily returns is about 1% both for the entire sample and for days OE-5 through OE+5.
To check the stability of the pattern, we next look at a recent subsample.
The next chart compares the average daily returns from OE-5 through OE+5 in the entire sample to those occurring since the beginning of 2003 (60 OE days). This chart has no error bars and uses a finer vertical scale than the preceding chart. The two patterns are similar, suggesting a little abnormal strength before OE and weakness immediately after. However, OE days themselves are not on average unusual.
Within the subsample, daily volatility is not notably unusual during OE-5 through OE+5.
Could returns on OE day be a function of what the market has done since the previous OE day? In other words, could preceding market action cause systematic repositioning by hedgers on OE day?
The following scatter plot relates OE day returns to the returns from the close on the last OE day through the day before OE day. For example, if two successive OE days are 11/16 and 12/21, the chart relates the return on 12/21 to the return during 11/16-12/20. Although the best-fit line has positive slope, the Pearson correlation between the two series is just 0.12 and the R-squared statistic is only 0.01, indicating little or no relationship. Perhaps continual adjustments by hedgers obviate any OE day price pressure.
In summary, there is some evidence that the overall stock market exhibits a little abnormal strength a few days before options expiration and weakness just after expiration. However, these tendencies appear too weak to trade.
For related research, see Blog Synthesis: Calendar Effects and the Trading Calendar.
