Stock Option Returns, A Puzzle

Under very weak assumptions, the expected returns of European call options must be positive and increasing in the strike price. This paper investigates the returns to call options on individual stocks that do not have an ex-dividend day prior to expiration. The main findings are that over the 1996 to 2005 period (1) out-of-the-money calls have negative average returns and (2) average returns of high strike calls are lower than those of low strike calls. Preliminary evidence is presented that is consistent with investor risk-seeking contributing to the puzzling call returns.