The asymmetry in day and night option returns: Evidence from an emerging market

• Published date: 01 August 2024
• Author: Aparna Bhat,Piyush Pandey,S. V. D. Nageswara Rao
• Date: 01 August 2024
• DOI: http://doi.org/10.1002/fut.22512

Received: 29 January 2024

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Accepted: 29 April 2024

DOI: 10.1002/fut.22512

RESEARCH ARTICLE

The asymmetry in day and night option returns: Evidence

from an emerging market

Aparna Bhat

1

|Piyush Pandey

2

|S. V. D. Nageswara Rao

2

1

K. J. Somaiya Institute of Management,

Somaiya Vidyavihar University, Mumbai,

India

2

Shailesh J. Mehta School of

Management, IIT Bombay, Mumbai,

India

Correspondence

Aparna Bhat, K. J. Somaiya Institute of

Management, Somaiya Vidyavihar

University, Mumbai, India.

Email: aparnabhat@somaiya.edu and

aparna.p.bhat@gmail.com

Abstract

Delta‐hedged option selling strategies typically yield positive returns, owing to

the volatility risk premium embedded in the option price. Recent research

based on S&P 500 options has found a day–night asymmetry in option returns.

We find a similar disparity in the returns for short Nifty option strategies.

Positive and significant overnight option returns are accompanied by negative

intraday returns. The day–night asymmetry is robust across option categories

and subsamples but weaker on days with significant jumps in the underlying.

We confirm that the variance risk premium earned by option sellers is mainly

a reward for overnight risk.

KEYWORDS

delta‐hedged options, intraday and overnight returns, Nifty options, variance risk premium

JEL CLASSIFICATION

G10, G13, G14

1|INTRODUCTION

It is a well‐documented stylized fact that the volatility of financial assets is stochastic. Options on financial assets are

often used for hedging against such time‐varying volatility in the underlying returns. However, there is empirical

evidence that option‐implied volatility is systematically higher than the subsequently realized volatility of the

underlying asset returns. This difference between the implied and realized variance (RV) of the asset returns is known

as the variance risk premium (VRP) and has been known to drive the returns for option selling strategies. The

pioneering study by Bakshi and Kapadia (2003) found significantly negative returns from long delta‐neutral positions

in S&P 500 call options, suggestive of a negative VRP embedded in the price of index options. Similar studies of returns

from currency options (Low & Zhang, 2005) and index options in other markets (Garg & Vipul, 2015) found evidence of

a negative VRP.

A common feature of these studies is that they were based on daily close‐to‐close option returns. However, a recent

study by Muravyev and Ni (2020) examined intraday and overnight returns separately for S&P 500 options. They found

that option buyers earned positive returns from their intraday long options positions but suffered losses on overnight

long positions. The finding of asymmetrical day–night returns for S&P 500 options is puzzling, given that the US

options market is one of the world's most actively traded derivatives markets. Index options in such a market can be

expected to be priced in an efficient manner. The results of Muravyev and Ni (2020) reveal a systematic bias in option

prices such that intraday option positions yield significant gains (losses) to option buyers (sellers), while overnight

positions result in losses (gains) for option buyers (sellers). These findings led the authors to conclude that the VRP

changes its sign from day to night; it is negative only for overnight long option positions but positive for intraday long

J Futures Markets. 2024;44:1320–1337.wileyonlinelibrary.com/journal/fut1320

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© 2024 Wiley Periodicals LLC.

option positions. The day–night asymmetry in option returns is evidence against market efficiency and has implications

for the investors' timing of option trades. It is worth investigating whether other actively traded options markets across

the world, apart from the US options market, exhibit such day–night asymmetry in returns. Interestingly, despite the

burgeoning literature on the day–night variation in index and stock returns (Branch & Ma, 2006; Kelly & Clark, 2011),

there is scant empirical evidence regarding such asymmetry in option returns.

Our study seeks to ascertain whether a day–night asymmetry is observed in the returns of Nifty options, which were

the second largest traded options contracts in the world (by traded volume) according to data released by the Futures

Industry Association for the year 2020. The Nifty 50 is a benchmark stock market index representing the weighted

average of 50 of the largest Indian companies listed on the National Stock Exchange of India (NSE). Nifty futures and

options are traded on the NSE, which, in 2019, became the largest derivatives exchange in the world by number of

contracts traded. Trading in equity derivatives in India enjoys significant participation by noninstitutional investors

compared with the US options market, which is dominated by professional market‐makers and institutional investors

(Muravyev, 2016). The liquidity of the Indian equity derivatives market, combined with its unique investor profile,

makes it an ideal setting for testing the results of Muravyev and Ni (2020) regarding the day–night asymmetry in index

options returns.

This study explores the profitability of intraday and overnight selling of Nifty options on the NSE during 2017–2020.

We examine the returns from selling Nifty options at the market open and closing the positions at market close

(intraday strategy) and returns from short positions opened at the market close and covered at the market open of the

next trading day (overnight strategy). Our findings can be summarized as follows. Segregation of the total daily returns

(open‐to‐open) from short options strategies into intraday (open‐to‐close) and overnight (close‐to‐open) returns shows

that while the daily and intraday mean returns are largely negative and insignificant, the overnight mean returns are

positive, and highly significant. The results are robust across different subsamples, calls, and puts with different

moneyness and times to maturity, after accounting for weekend returns, and after considering alternative transaction

prices and trade timings. The difference in overnight and intraday returns is, however, attenuated on days with

significant jumps in the underlying index. The overall findings are supportive of the notion that the VRP is a reward to

option sellers for bearing the risk of fluctuations in overnight index returns alone.

We contribute to extant literature in the following ways. First, we extend the main findings of Muravyev and Ni

(2020), MN henceforth, by providing additional evidence regarding the existence of a day–night asymmetrical pattern

in option returns in an important emerging market, like, India. Despite the significant body of research about the

day–night pattern in equity market returns, any such pattern in the returns from options has been largely unexplored.

Our study adds to the limited research in this domain. Second, while MN examined S&P 500 option returns over an

earlier period (2004–2013) our study is based on a contemporary data sample that covers the market shocks resulting

from the several waves of the Covid‐19 pandemic and the subsequent recovery in the equity markets. The fact that our

study, although rooted in a different market and conducted over a recent period, substantiates the findings of MN

suggests that option traders are prone to the same behavioral errors, regardless of the level of sophistication of the

market. Third, we find that the day–night volatility bias, which was the favored explanation in MN cannot account for

the day–night asymmetry observed in Nifty options returns. Finally, we note a different pattern in the profitability of

short call and short put positions during the prenoon and postnoon intervals of the trading day, implying that the VRP

changes across the trading day, but differently for calls and puts.

The rest of the paper is organized as follows. Section 2discusses the extant literature regarding the profitability of

short option strategies. Section 3explains the methodology, while Section 4is about the research setting and data

description. Section 5discusses the empirical findings of the study, and Section 6concludes the study and states its

implications.

2|RELATED LITERATURE

A dominant strand of research focused on detecting whether option sellers demanded a premium for hedging against

the time‐varying volatility of underlying asset returns. Coval and Shumway (2001) and Bakshi and Kapadia (2003)

adopted a nonparametric approach of showing that a positive vega strategy of buying delta‐hedged calls on the S&P 500

index resulted in large and economically significant losses. Such losses incurred by buyers of options were seen as

evidence of a significant VRP embedded in option prices. Low and Zhang (2005) examined returns from OTC options

on currency majors, such as the British Pound, the Euro, the Yen, and the Swiss Franc, and concluded that volatility

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