We investigate the relation between the option returns and the underlying stock's lottery-like characteristics. Call options written on the most lottery-like stocks underperform otherwise similar call options written on the least lottery-like stocks by 10–20% per month. Moreover, the more lottery-like the underlying stocks, the further and more frequently the options deviate from the put–call parity in the direction induced by overvalued calls. Furthermore, the lottery-like characteristic effect is stronger during periods of high investor sentiment. The results suggest that optimism-induced gambling preference causes lottery-like options to be overvalued.

It is well documented that stocks with lottery-like characteristics are overpriced. We find that the lottery-related anomaly exists primarily among stocks that are far from their 52-week high prices. When implemented among such stocks, the strategy of buying the least lottery-like stocks and selling the most delivers a significantly positive risk-adjusted return of 2.22% per month. In contrast, it yields an insignificant negative return of -0.31% per month for stocks near their 52-week high. The pattern holds after controlling for capital gains overhang and idiosyncratic volatility. We also find that investors’ optimistic earnings forecasts for lottery-like stocks are attenuated by their nearness to the 52-week high. Our findings suggest that investors consider the 52-week high as the upper price limit and that this psychological barrier affects their preferences for lottery-like stocks.