Index Option Prices and Stock Market Momentum

Abstract

We test the prediction of standard option pricing models that there should be no relation between option prices and past stock market movements. Using the Standard and Poor's 100 index options (OEX options) prices from 1983–1995, we document that OEX calls are significantly overvalued relative to OEX puts after large stock price increases. The reverse is true after large stock price decreases. These valuation effects are both economically and statistically significant. Our results suggest that past stock returns exert an important influence on index option prices.