Individual Investors and Option Trading: Attention Grabbing Versus Long-Term Strategies

Abstract

This paper analyzes trading records of online retail bank investors to examine whether attention-type events dominate return feedback strategies in explaining individual investors’ stock option trading decisions. We show that although individual investors are net buyers of common stock on abnormally high volume days, they follow contrarian investment strategies after extreme prior day stock price performance. Moreover, we find that individual investors especially exploit stock options to follow contrarian investment strategies in that they initiate over twice as many bullish-type (nearly half as many bearish-type) option contracts after extremely poor (good) prior-day returns. Further, we observe variance in contrarian behavior across investor types: extremely optimistic investors pursue contrarian investment strategies more (less) pronounced around highly negative (positive) prior day returns. Finally, we show that the same extreme optimists especially overweigh short-term compared to long-term return feedback information in making individual stock option trading decisions. Combined, this study provides novel insights in the dynamics of individual investors’ option trading decisions and in the distinctive roles of cognitive biases underlying this process.