Stock Option Momentum and Seasonality

Do options of individual stocks exhibit momentum and seasonality patterns? In their November 2020 paper entitled “Momentum, Reversal, and Seasonality in Option Returns”, Christopher Jones, Mehdi Khorram and Haitao Mo investigate momentum and seasonality effects for options on U.S. common stocks. They focus on performance of straddles, combining a put and a call with the same strike price and expiration date. They balance needs for liquidity and sample size by requiring positive open interest during the holding period but not the momentum calculation interval. Specifically, on each monthly option expiration date, they:

1. Form two straddles from near-the-money options expiring next month for each for each stock: (1) the pair with call delta closest to 0.5 for calculating momentum; and, (2) the pair with call delta closest to 0.5 and with positive open interest for both the put and the call when selected for calculating momentum portfolio return.
2. Construct from these pairs zero-delta straddles using bid-ask midpoints as prices and calculate monthly straddle excess returns relative to the 1-month Treasury bill yield. This process generates about 1,600 straddles per month with average monthly excess return -5.6% and very large standard deviations.
3. Calculate momentum as average monthly excess return over a specified lookback interval (rather than cumulative return, to suppress effects of return outliers).
4. Rank straddle returns into equal-weighted fifths (quintiles) based on momentum and calculate average return for each quintile and for a portfolio that is long the top quintile and short the bottom quintile.

Using end-of-day open interest and bid-ask quotes for call and put options on U.S. common stocks from OptionMetric and trading data for underlying stocks during January 1996 through June 2019, they find that: (more…)