IDEAS home Printed from https://ideas.repec.org/p/ags/nccc09/53047.html
   My bibliography  Save this paper

Liquidity Costs in Futures Options Markets

Author

Listed:
  • Shah, Samarth
  • Brorsen, B. Wade
  • Anderson, Kim B.

Abstract

The major finding is that liquidity costs in futures options market are two to three times higher than liquidity costs in the futures market. Liquidity cost is one potential factor to consider when choosing between hedging with a futures contract or with an option contract. While there is considerable research that estimates liquidity costs of futures trading, there is little comparable research about options markets. This study, for the first time, attempts to determine and compare liquidity costs in options and futures markets. The study uses July 2007 wheat futures and options contracts traded on Kansas City Board of Trade. Two measures of liquidity costs were used for both options and futures markets. One measure of liquidity costs in options markets is the average bid-ask spread that is calculated from the available bidask quotes. A new measure of liquidity costs in options markets is derived based on the Black model and it uses trade prices instead of observed bid-ask quotes. The liquidity costs in the options market was estimated to be 1.60 cents per bushel using observed bid-ask spreads and it was 1.37 cents per bushel when the new measure was used. Liquidity costs in the futures markets are estimated using Roll’s measure and average absolute price changes. The estimates were 0.45 and 0.49 cents per bushel, respectively for futures contracts. A positive relation was found between option liquidity costs and moneyness of the option. Days to expiration of the contracts was not statistically significant in explaining the liquidity cost of the option.

Suggested Citation

  • Shah, Samarth & Brorsen, B. Wade & Anderson, Kim B., 2009. "Liquidity Costs in Futures Options Markets," 2009 Conference, April 20-21, 2009, St. Louis, Missouri 53047, NCCC-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    • Handle: RePEc:ags:nccc09:53047
    DOI: 10.22004/ag.econ.53047
    as

    Download full text from publisher

    File URL: https://ageconsearch.umn.edu/record/53047/files/confp13-09.pdf
    Download Restriction: no
    File URL: https://libkey.io/10.22004/ag.econ.53047?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Baesel, Jerome B & Shows, George & Thorp, Edward, 1983. "The Cost of Liquidity Services in Listed Options: A Note," Journal of Finance, American Finance Association, vol. 38(3), pages 989-995, June.
    2. Thomas V. Greer & B. Wade Brorsen & Shi-Miin Liu, 1992. "Slippage Costs in Order Execution for a Public Futures Fund," Review of Agricultural Economics, Agricultural and Applied Economics Association, vol. 14(2), pages 281-288.
    3. Scott H. Irwin & B. Wade Brorsen, 1985. "Public futures funds," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 5(3), pages 463-485, September.
    4. Thompson, Sarahelen R. & Eales, James S. & Seibold, David, 1993. "Comparison Of Liquidity Costs Between The Kansas City And Chicago Wheat Futures Contracts," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 18(2), pages 1-13, December.
    5. Townsend, John P. & Brorsen, B. Wade, 2000. "Cost Of Forward Contracting Hard Red Winter Wheat," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 32(1), pages 1-6, April.
    6. B. Wade Brorsen & John Coombs & Kim Anderson, 1995. "The cost of forward contracting wheat," Agribusiness, John Wiley & Sons, Ltd., vol. 11(4), pages 349-354.
    7. B. Wade Brorsen, 1989. "Liquidity costs and scalping returns in the corn futures market," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 9(3), pages 225-236, June.
    8. Thompson, S. & Waller, M.L., 1988. "Determinants Of Liquidity Costs In Commodity Furures Markets," Papers 172, Columbia - Center for Futures Markets.
    9. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
    10. George H. K. Wang & Jot Yau & Tony Baptiste, 1997. "Trading volume and transaction costs in futures markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 17(7), pages 757-780, October.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Carl R. Zulauf & Scott H. Irwin, 1998. "Market Efficiency and Marketing to Enhance Income of Crop Producers," Review of Agricultural Economics, Agricultural and Applied Economics Association, vol. 20(2), pages 308-331.
    2. Elam, Emmett W., 1992. "Cash Forward Contracting Versus Hedging Of Fed Cattle, And The Impact Of Cash Contracting On Cash Prices," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 17(1), pages 1-13, July.
    3. Thompson, Sarahelen R. & Eales, James S. & Seibold, David, 1993. "Comparison Of Liquidity Costs Between The Kansas City And Chicago Wheat Futures Contracts," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 18(2), pages 1-13, December.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Park, Cheol-Ho & Irwin, Scott H., 2004. "The Profitability Of Technical Trading Rules In Us Futures Markets: A Data Snooping Free Test," 2004 Conference, April 19-20, 2004, St. Louis, Missouri 19011, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    2. Henry Bryant & Michael Haigh, 2004. "Bid-ask spreads in commodity futures markets," Applied Financial Economics, Taylor & Francis Journals, vol. 14(13), pages 923-936.
    3. Nicola Secomandi & Sunder Kekre, 2014. "Optimal Energy Procurement in Spot and Forward Markets," Manufacturing & Service Operations Management, INFORMS, vol. 16(2), pages 270-282, May.
    4. Bryant, Henry L. & Haigh, Michael S., 2002. "Bid-Ask Spreads In Commodity Futures Markets," Working Papers 28587, University of Maryland, Department of Agricultural and Resource Economics.
    5. Julieta Frank & Philip Garcia, 2011. "Measuring the cost of liquidity in agricultural futures markets: Conventional and Bayesian approaches," Agricultural Economics, International Association of Agricultural Economists, vol. 42, pages 131-140, November.
    6. Valeria Martinez & Paramita Gupta & Yiuman Tse & Jullavut Kittiakarasakun, 2011. "Electronic versus open outcry trading in agricultural commodities futures markets," Review of Financial Economics, John Wiley & Sons, vol. 20(1), pages 28-36, January.
    7. Miao Li & Tao Xiong & Ziran Li, 2023. "A tale of two contracts: Examining the behavior of bid–ask spreads of corn futures in China," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(6), pages 792-806, June.
    8. Pennings, Joost M.E. & Garcia, Philip & Marsh, Julia W., 2003. "Futures Market Depth: Revealed Vs. Perceived Price Order Imbalances," 2003 Conference, April 21-22, 2003, St. Louis, Missouri 18989, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    9. Good, Darrel L. & Irwin, Scott H. & Martines-Filho, Joao Gomes & Hagedorn, Lewis A., 2005. "The Pricing Performance of Market Advisory Services in Corn and Soybeans over 1995-2003," AgMAS Project Research Reports 14775, University of Illinois at Urbana-Champaign, Department of Agricultural and Consumer Economics.
    10. Shah, Samarth & Brorsen, B. Wade & Anderson, Kim B., 2012. "Effective Bid-Ask Spreads in Futures versus Futures Options," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 37(3), pages 1-14.
    11. Yiuman Tse & Paramita Bandyopadhyay, 2006. "Multi-market trading in the Eurodollar futures market," Review of Quantitative Finance and Accounting, Springer, vol. 26(3), pages 321-341, May.
    12. Martinez, Valeria & Gupta, Paramita & Tse, Yiuman & Kittiakarasakun, Jullavut, 2011. "Electronic versus open outcry trading in agricultural commodities futures markets," Review of Financial Economics, Elsevier, vol. 20(1), pages 28-36, January.
    13. Taylor, Mykel & Tonsor, Glynn & Dhuyvetter, Kevin, 2014. "Structural Change in Forward Contracting Costs for Kansas Wheat," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 39(2), pages 1-13.
    14. Peter Slade, 2021. "The impact of price hedging on subsidized insurance: Evidence from Canada," Canadian Journal of Agricultural Economics/Revue canadienne d'agroeconomie, Canadian Agricultural Economics Society/Societe canadienne d'agroeconomie, vol. 69(4), pages 447-464, December.
    15. Mallory, Mindy L. & Zhao, Wenjiao & Irwin, Scott H., 2012. "Farmer’s Income Shifting Option in Post-harvest Forward Contracting," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington 124692, Agricultural and Applied Economics Association.
    16. Taylor, Mykel R. & Dhuyvetter, Kevin C. & Kastens, Terry L., 2006. "Forecasting Crop Basis Using Historical Averages Supplemented with Current Market Information," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 31(3), pages 1-19, December.
    17. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    18. Julieta Frank & Philip Garcia, 2010. "Bid-Ask Spreads, Volume, and Volatility: Evidence from Livestock Markets," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 93(1), pages 209-225.
    19. Bradley Isbell & Andrew M. McKenzie & B. Wade Brorsen, 2020. "The cost of forward contracting in the Mississippi barge freight river market," Agribusiness, John Wiley & Sons, Ltd., vol. 36(2), pages 226-241, April.
    20. Lorne N. Switzer & Haibo Fan, 2010. "Limit Orders, Trading Activity, and Transactions Costs in Equity Futures in an Electronic Trading Environment," International Econometric Review (IER), Econometric Research Association, vol. 2(1), pages 11-35, April.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ags:nccc09:53047. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: AgEcon Search (email available below). General contact details of provider: https://edirc.repec.org/data/dauiuus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.