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Article
Publication date: 11 March 2021

Bei Chen and Quan Gan

This paper investigates how the gambling measure captures market bubble events, and how it predicts stock return and option return.

Abstract

Purpose

This paper investigates how the gambling measure captures market bubble events, and how it predicts stock return and option return.

Design/methodology/approach

This paper proposes a gambling activity measure by jointly considering open interest and moneyness of out-of-the-money (OTM) individual equity call options.

Findings

The new measure, CallMoney, captures excessive optimism during the dot-com bubble, the oil price bubble and the pre-GFC stock market bubble. CallMoney robustly and negatively predicts both OTM and at-the-money call option returns cross-sectionally. The option return predictability of CallMoney is stronger when stock price is further from its 52-weeks high, capital gains overhang is lower, and when information uncertainty of the underlying stock is higher. CallMoney also robustly and negatively predicts cross-sectional stock returns.

Originality/value

The gambling measure has the advantages of being economically intuitive, model-free, easy to measure. The measure performs more robustly than existing lottery measures with respect to option and stock return predictability and more reliably captures the overpricing of options and stocks. The work helps understanding the gambling related anomalies in equity option returns and stock returns.

Details

Review of Behavioral Finance, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1940-5979

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Article
Publication date: 22 September 2017

Ryan McKeon

The purpose of this paper is to conduct an empirical analysis of the pattern of time value decay in listed equity options, considering both call and put options and…

Abstract

Purpose

The purpose of this paper is to conduct an empirical analysis of the pattern of time value decay in listed equity options, considering both call and put options and different moneyness and maturity levels.

Design/methodology/approach

The research design is empirical, with great attention paid to creating a standardized measure of time value that can be both tracked over time for an individual option contract and meaningfully compared across two or more different option contracts.

Findings

The author finds that moneyness classification at the beginning of the holding period is the key determinant of the pattern of subsequent time decay. The type of option, call or put, and the maturity of the contract have surprisingly little relevance to the pattern of time decay “out-the-money contracts having similar patterns on average, regardless of whether they are calls or puts, 30-day or 60-day contracts.” More detailed analysis reveals that In-the-money and out-the-money contracts have slow time decay for most of the contract life, with a significant percentage of the time decay concentrated on the final day of the option. At-the-money contracts experience strong decay early in the life of the option.

Research limitations/implications

The study is limited by not having intra-day data included to analyze more frequent price movements.

Practical implications

The results reported in the paper provide insight into issues of active management facing options traders, specifically choices such as the initial maturity of the option contract and rollover frequency.

Originality/value

Very few studies examine the important issue of how option time value behaves. Time value is the subjective part of the option contract value, and therefore very difficult to predict and understand. This paper provides insight into typical empirical patterns of time value behavior.

Details

China Finance Review International, vol. 7 no. 4
Type: Research Article
ISSN: 2044-1398

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Article
Publication date: 1 October 1995

M. Ariff, P.K. Chan and L.W. Johnson

Three years after the introduction of exchange‐traded options on the American scene, a call options market was made with ten popular common stocks in Singapore in early…

Abstract

Three years after the introduction of exchange‐traded options on the American scene, a call options market was made with ten popular common stocks in Singapore in early 1977. Only calls were traded and no puts were introduced. After six months of trading actively, volume dwindled, and the market was withdrawn in early 1980. Three currency options markets introduced in 1987 continues to thrive at the time of this study. The reason for the demise of the call options market is mainly the significant mispricing of the contracts as most contracts were systematically above the theoretical fair prices. Low volatility in the spot market after the calls were introduced, availability of alternative speculative instrument for traders, high transaction costs and the lack of knowledge about the complexity of options trades are suggested as reasons for the failure of the market. As a new options market has been introduced again in March, 1993, it is worthwhile to learn from the past.

Details

Managerial Finance, vol. 21 no. 10
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 1 March 2002

ROBERT G. TOMPKINS

The depth and breadth of the market for contingent claims, including exotic options, has expanded dramatically. Regulators have expressed concern regarding the risks of…

Abstract

The depth and breadth of the market for contingent claims, including exotic options, has expanded dramatically. Regulators have expressed concern regarding the risks of exotics to the financial system, due to the difficulty of hedging these instruments. Recent literature focuses on the difficulties in hedging exotic options, e.g., liquidity risk and other violations of the standard Black‐Scholes model. This article provides insight into hedging problems associated with exotic options: 1) hedging in discrete versus continuous time, 2) transaction costs, 3) stochastic volatility, and 4) non‐constant correlation. The author applies simulation analysis of these problems to a variety of exotics, including Asian options, barrier options, look‐back options, and quanto options.

Details

The Journal of Risk Finance, vol. 3 no. 4
Type: Research Article
ISSN: 1526-5943

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Article
Publication date: 9 May 2016

William Trainor and Richard Gregory

Leveraged exchange traded funds (ETFs) have become increasingly popular since their introduction in 2006. In recent years, options on leveraged ETFs have been promoted as…

Abstract

Purpose

Leveraged exchange traded funds (ETFs) have become increasingly popular since their introduction in 2006. In recent years, options on leveraged ETFs have been promoted as a means of enhancing returns and reducing risk. The purpose of this paper is to examine the interchangeability of S & P 500 ETF options with leveraged S & P 500 ETF options and to what extent these options allow investors to manage their risk exposure.

Design/methodology/approach

With increasing liquidity for these fund’s options, simple option strategies such as covered calls and protective puts can be implemented. This study derives call-call and put-put parity between options on the underlying index and the associated leveraged ETFs. The paper examines comparative measures of return and risk on the underlying indices, along with covered call and protective put positions.

Findings

Using the formulations derived, this study shows options on non-leveraged ETFs or on the underlying index can be substituted for leveraged ETF options. Empirical results suggest substituting options on leveraged ETFs with options on the underlying index or index ETF give comparable results, but can differ as the realized leverage ratio over time differs from projected values.

Originality/value

This study is the first to the authors’ knowledge that investigates option strategies on leveraged and inverse ETFs of equity indices. It is also the first to derive call-call and put-put parity relations between options on ETFs and related leveraged and inverse ETFs. The results contribute to securities issuance, investment strategies, and option parity relations.

Details

Managerial Finance, vol. 42 no. 5
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 31 March 2020

Izidin El Kalak and Robert Hudson

This study aims to examine the cross-market efficiency of the FTSE/MIB index options contracts traded on the Italian derivatives market (IDEM) during a period including…

Abstract

Purpose

This study aims to examine the cross-market efficiency of the FTSE/MIB index options contracts traded on the Italian derivatives market (IDEM) during a period including the financial crisis between 1st October 2007 and 31st December 2012 using daily option prices.

Design/methodology/approach

Two fundamental no-arbitrage conditions were tested: the lower boundary condition (LBC) and the put–call parity (PCP) condition while taking into account the role of transaction costs in mitigating the number of violations reported. Ex post tests of LBC and PCP revealed a low incidence of mispricing in this market. Furthermore, to check the robustness of the results obtained by the ex post tests, ex ante tests were applied to PCP violations occurring within a one-day lag.

Findings

The results showed a significant drop in the number of profitable arbitrage strategies. The findings obtained from all these tests generally support the cross-market efficiency of the Italian index options market during the sample period, though some violations were occasionally reported. Overall, the number and monetary value of the violations reported declined during the post-financial crisis period compared to those during the financial crisis period.

Research limitations/implications

This study can be extended to test the relationships between arbitrage profitability and other factors such as the moneyness (in the money, out of the money, at the money) of options and the maturity of options. Options market efficiency tests can be conducted such as call and put spreads, box spreads and put/call convexities (butterfly spreads).

Originality/value

There are several factors that influenced the decision to test the Italian index options market. First, the limited number of studies conducted on this market. Second, the fact that the two main studies on this market are relatively old, which makes it interesting to test the efficiency of this market with respect to a new set of data, taking into account the introduction of the Euro and the impact of the recent financial crisis on this market and whether the market efficiency hypothesis holds during the period of crisis. Third, it is important to consider the effect of the new rules applied to this market.

Details

Review of Accounting and Finance, vol. 19 no. 2
Type: Research Article
ISSN: 1475-7702

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Article
Publication date: 7 November 2016

Narain, Narander Kumar Nigam and Piyush Pandey

The purpose of this paper is to understand the patterns of the implied volatility (IV) of the Indian index option market and its relationship with moneyness (called the…

Abstract

Purpose

The purpose of this paper is to understand the patterns of the implied volatility (IV) of the Indian index option market and its relationship with moneyness (called the volatility smile). Its goal is also to ascertain the determinants of IV.

Design/methodology/approach

For this purpose, IVs were computed from the daily call and put data of CNX Nifty index options from April 2004 to March 2014. The patterns of IVs were analysed using univariate parametric tests. Multivariate regression analyses were conducted to understand the relationships observed. Resultantly, vector autoregressions were performed to assess the determinants of IV.

Findings

The results suggested that there was asymmetric volatility across time and strike prices using alternative measures of moneyness. Furthermore, it was found that the IV of lower strike prices was significantly higher (lower) than that of higher strike prices for call (put) options. Put IV was observed to be higher than call IV irrespective of any attributes. The results further showed that current-month contracts have significantly higher IV than those for next month and those were followed by far-month contracts. Nifty futures’ volumes and momentum were found to be significant determinants of IV.

Practical implications

The behaviour of the volatility smile is important when accounting for the Vega risks in the portfolios of hedge fund managers. While taking a position, besides the Black-Scholes-Merton (BSM) model’s input factors, investors must consider the previous behaviour of volatility, a market’s microstructures and its liquidity for a put option contract. They must also consider the attributes of the underlying for a call option contract.

Originality/value

This is the first decadal study (the longest span of data for any international study on this subject) to confirm the existence of the volatility smile for the index options market in India. It examines and confirms the smile’s asymmetry patterns for different definitions of moneyness, as well as option types, the tenure of options contracts and the different phases of market conditions. It further helps to identify the determinants of IV and so has renewed importance for traders.

Details

Journal of Advances in Management Research, vol. 13 no. 3
Type: Research Article
ISSN: 0972-7981

Keywords

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Abstract

Details

An Introduction to Algorithmic Finance, Algorithmic Trading and Blockchain
Type: Book
ISBN: 978-1-78973-894-0

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Book part
Publication date: 6 January 2016

Michel van der Wel, Sait R. Ozturk and Dick van Dijk

The implied volatility surface is the collection of volatilities implied by option contracts for different strike prices and time-to-maturity. We study factor models to…

Abstract

The implied volatility surface is the collection of volatilities implied by option contracts for different strike prices and time-to-maturity. We study factor models to capture the dynamics of this three-dimensional implied volatility surface. Three model types are considered to examine desirable features for representing the surface and its dynamics: a general dynamic factor model, restricted factor models designed to capture the key features of the surface along the moneyness and maturity dimensions, and in-between spline-based methods. Key findings are that: (i) the restricted and spline-based models are both rejected against the general dynamic factor model, (ii) the factors driving the surface are highly persistent, and (iii) for the restricted models option Δ is preferred over the more often used strike relative to spot price as measure for moneyness.

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Book part
Publication date: 10 December 2018

George Levy

Abstract

Details

Energy Power Risk
Type: Book
ISBN: 978-1-78743-527-8

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