Option Market Microstructure

In this chapter, we study the problem of the bid–ask spread formation on option markets. The market microstructure literature tried to study the behavior of market makers, and the elements they take into account when they calculate the size and the quantities of their spread using three complementary theoretical approaches — transaction costs, inventory costs, and asymmetry information costs. In order to overlap the limits of existing models which are not able to integrate these three types of costs, we developed an empirical approach.Our research of the French market shows that modeling an option bid–ask spread is first and foremost a question of evaluating this option, and, second, a problem of microstructure. Moreover, the existence of moderate asymmetry information costs shows that this market is not dominated by informed operators, contrary to the generally accepted ideas concerning this type of derivatives market. In addition, we have demonstrated that the stock market liquidity characteristics are transmitted to their option. So, the interactions between the stock and the option spread are strong and the liquidity of the stock market determines the efficiency of the option market.