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Are Options on Index Futures Profitable for Risk Averse Investors? Empirical Evidence

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Author Info
Jens Carsten Jackwerth () (Universität Konstanz)
George M. Constantinides
Michal Czerwonko
Stylianos Perrakis

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Abstract

American call and put options on the S&P 500 index futures that violate the stochastic dominance bounds of Constantinides and Perrakis (2007) over 1983-2006 are identified as potentially profitable investment opportunities. Call bid prices more frequently violate their upper bound than put bid prices do, while evidence of underpriced calls and puts over this period is scant. In out-of-sample tests, the inclusion of short positions in such overpriced calls, puts, and, particularly, straddles in the market portfolio is shown to increase the expected utility of any risk averse investor and also increase the Sharpe ratio, net of transaction costs and bid-ask spreads. The results are strongly supportive of mispricing. (JEL G11, G13, G14)

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Paper provided by Center of Finance and Econometrics, University of Konstanz in its series CoFE Discussion Paper with number 08-08.

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Length: 42 pages
Date of creation: 16 Mar 2008
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Handle: RePEc:knz:cofedp:0808

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  3. Constantinides, George M. & Perrakis, Stylianos, 2002. "Stochastic dominance bounds on derivatives prices in a multiperiod economy with proportional transaction costs," Journal of Economic Dynamics and Control, Elsevier, vol. 26(7-8), pages 1323-1352, July. [Downloadable!] (restricted)
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  5. Mark Rubinstein., 1994. "Implied Binomial Trees," Research Program in Finance Working Papers RPF-232, University of California at Berkeley. [Downloadable!]
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  8. Jobson, J D & Korkie, Bob M, 1981. "Performance Hypothesis Testing with the Sharpe and Treynor Measures," Journal of Finance, American Finance Association, vol. 36(4), pages 889-908, September. [Downloadable!] (restricted)
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  10. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring. [Downloadable!] (restricted)
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  1. Constantinides, George M. & Jackwerth, Jens Carsten & Perrakis, Stylianos, 2007. "Option Pricing: Real and Risk-Neutral Distributions," MPRA Paper 11637, University Library of Munich, Germany. [Downloadable!]
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