Salience theory and option returns

In multiple asset classes, the pricing implications of salience theory on cross-sectional asset returns are clouded by informational overlaps with short-term past returns. Leveraging the delta-neutral nature of the delta-hedged option returns, this paper documents the first unclouded evidence of salience theory's impact in the options market. We introduce a new option-based salience theory (OST) value and find its strong negative predictive power for cross-sectional option returns: a long-short portfolio sorted by OST generates a monthly return spread of −0.57% and an annualized Sharpe ratio of 1.86. Our findings support the hypothesis that investors overweight salient past option returns, resulting in the overvaluation of high-OST options. Furthermore, the option salience effect cannot be explained by stock-based short-term reversal or past-month option returns, and is stronger when investor sentiment is high, limits to arbitrage are elevated, and volatility is heightened.