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Market Frictions and Seemingly Anomalous Co-movements of Index Options and Index Futures Quotes

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  • Fahlenbrach, Rudiger

    (Ohio State U)

  • Sandas, Patrik

    (U of Pennsylvania)

Abstract

A call option price is always an increasing and convex function of the underlying asset price whenever the underlying asset price follows a diffusion whose volatility depends only on time and the concurrent asset price-a one-dimensional diffusion. We empirically examine how often the observed quote movements are anomalous in the sense that they imply a violation of either the monotonicity or the convexity property using a sample of quotes and trades of options and futures on the FTSE 100 stock index. We show that such anomalous co-movements are about four times more likely to occur within a minute of an option trade than at other times and are related to the traders' order submissions. We interpret our results as evidence that the seemingly anomalous quote co-movements are driven by market frictions and should not be taken as evidence against option pricing models in the one-dimensional diffusion family. We show that the seemingly anomalous quote co-movements are consistent with traders making rational order submission decisions.

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Bibliographic Info

Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2005-10.

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Date of creation: Jan 2005
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Handle: RePEc:ecl:ohidic:2005-10

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  1. Yaacov Z. Bergman & Bruce D. Grundy & Zvi Wiener, . "General Properties of Option Prices (Revision of 11-95) (Reprint 058)," Rodney L. White Center for Financial Research Working Papers 1-96, Wharton School Rodney L. White Center for Financial Research.
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  12. Mayhew, Stewart & Sarin, Atulya & Shastri, Kuldeep, 1995. " The Allocation of Informed Trading across Related Markets: An Analysis of the Impact of Changes in Equity-Option Margin Requirements," Journal of Finance, American Finance Association, vol. 50(5), pages 1635-53, December.
  13. Kalok Chan & Y. Peter Chung & Wai-Ming Fong, 2002. "The Informational Role of Stock and Option Volume," Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1049-1075.
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  15. Bergman, Yaacov Z & Grundy, Bruce D & Wiener, Zvi, 1996. " General Properties of Option Prices," Journal of Finance, American Finance Association, vol. 51(5), pages 1573-1610, December.
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