December 3, 2019
We show that microstructure biases in the estimation of expected option returns and risk premia are large, in some cases over 50 basis points per day. We propose a new method that corrects for these biases. We then apply our method to real data and produce three main findings. First, the expected returns of straddles and delta-hedged options written on the S&P 500 Index are smaller than previously estimated in the literature.