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A moneyness‐based propensity to sell (MPS) measure, at the aggregate level, determines the propensity of option holders to exercise their winning relative to losing positions. Using data on individual stock and S&P 500 Index options, we find that the MPS measure has significant predictive power over the cross section of delta‐hedged option returns. We test the disposition effect in the options market based on a long–short strategy that exploits price distortions induced by the disposition bias. More pronounced evidence of the disposition bias is found for individual at‐the‐money call options than put options where the significance of abnormal returns remains robust across different subsamples even after we control for the portfolio option greeks and market‐based risk factors. The profitability of the long–short strategy is related to limit‐to‐arbitrage proxies suggesting that behavioral explanations help explain the positive relation between the MPS measure and delta‐hedged option returns.

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