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From Arbitrage Removal to Density Extraction: A Model-Free Framework for Short-Dated Options

Author

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  • Aaron Wizman
  • Gabriel Turinici
  • Gregory Merran

Abstract

We study risk-neutral density extraction from short-dated option chains. As expiry approaches, option premia decline and bid--ask spreads can be large relative to prices, making mid quotes particularly uninformative. Stale or asynchronous quotes may also generate potential static arbitrages, rendering standard procedures infeasible or unstable. We develop a model-free pipeline that treats bid-ask quotes as the primitive market constraint. The pipeline consists of two steps. First, a procedure called ``Arbitrage Removal Iterative Executable Strategy'' (ARIES) filters executable static arbitrage at quoted bid and ask prices under market-depth constraints. Second, the ``Smooth Entropic Density EXtraction'' (SEDEx) then recovers the density through a criterion leveraging smoothness and entropy under bid-ask constraints. We test the pipeline on synthetic Heston panels and short-dated SPX option data, sampled from a few hours to one week before expiry. Computation is fast and returns robust densities across various market conditions, including scheduled macroeconomic announcements. As an empirical application, we use the recovered densities to construct short dated implied-volatility smiles.

Suggested Citation

  • Aaron Wizman & Gabriel Turinici & Gregory Merran, 2026. "From Arbitrage Removal to Density Extraction: A Model-Free Framework for Short-Dated Options," Papers 2605.22792, arXiv.org.
    • Handle: RePEc:arx:papers:2605.22792
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