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Sell Equity Index OTM Put Options and ATM Straddles?

Posted in Equity Options

Does accounting for realistic trading frictions support beliefs that equity index out-of-the money (OTM) put options and at-the-money (ATM) straddles are systematically overpriced? In their October 2018 paper entitled "Index Option Anomalies: How Real Are They?", Michal Czerwonko and Stylianos Perrakis re-examine assumptions and data used in several high-profile studies finding that OTM put options and ATM straddles for the S&P 500 Index are overpriced, and that shorting these positions is therefore reliably profitable. They focus on the following aspects of option pricing: accounting for realistic trading frictions (bid-ask spreads); differences in pricing of same-strike price puts and calls; and, inconsistency in pricing across maturities. Using groomed intraday prices and quotes for S&P 500 Index (cash-settled) options 28, 14, and seven days to maturity during January 1990 through February 2013 (278 settlement dates), they find that:

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