Option Demands and Investment Horizon Effects

Abstract

This paper investigates the effect of investment horizon on the optimal portfolio choice of investors, who can access to index options market. This is to reconcile the empirical anomaly of Driessen and Maenhout (2007), which suggested that it is always optimal to short OTM puts and ATM straddles, regardless of investors’ preferences. Using the intraday data on KOSPI200 index options, one of the most actively traded options in the world, we analyze the differences in optimal choice between ‘position traders (i.e., long-term investors)’ and ‘day traders (i.e., short-term investor)’. Our main empirical findings are summarized as follows. First, short horizon investors who do not want to hold overnight option positions tend to optimally take a long position in options, whereas long horizon investors tend to hold short option positions. Second, these differences in optimal choice between short- and long-horizon investors are clearly evident in OTM puts rather than ATM straddles. Finally, our empirical findings are still valid even after considering alternative preferences structures of investors, transaction costs, different data filtering rules, and the effect of the Global financial crisis.