Is the Information on the Higher Moments of Underlying Returns Correctly Reflected in Option Prices?

This study examines the information implied in options with short and long maturities. In the analysis using the forward moments, we find that long‐term option investors, on average, seem to underestimate the third moment relative to short‐term option investors, and this becomes severe when the market variance is large. We find that the third moment underestimation of long‐term option investors is economically meaningful using Corrado and Su's model and a trading strategy exploiting the relative underestimated skewness in long‐term options. The abnormal return of the strategy is around 7% per year after controlling systematic risks.