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

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.