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Index Options-Futures Arbitrage: A Comparative Study with Bid/Ask and Transaction Data

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  • Fung, Joseph K W
  • Mok, Henry M K

Abstract

We can infer from bid/ask quotations and transaction prices that where options contracts are traded under a competitive open-outcry market-making system, the options and futures markets are dynamically efficient. Ex-ante analysis shows that potential arbitrage opportunities disappear within five minutes. Transaction price data understate both the frequency and magnitude of arbitrage opportunities that are signaled by bid/ask quotes. Quotes stale fast, so opportunities are short-lived and some of the arbitrage opportunities are deceptive. Nonetheless, the evidence suggests that bid/ask quotes provide valuable trading signals to arbitrageurs. Profitability from exploiting the quotes is negatively related to execution delay and execution risk. Copyright 2001 by MIT Press.

Suggested Citation

  • Fung, Joseph K W & Mok, Henry M K, 2001. "Index Options-Futures Arbitrage: A Comparative Study with Bid/Ask and Transaction Data," The Financial Review, Eastern Finance Association, vol. 36(1), pages 71-94, February.
    • Handle: RePEc:bla:finrev:v:36:y:2001:i:1:p:71-94
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    Cited by:

    1. Marianna Brunetti & Roberta De Luca, 2023. "Pairs trading in the index options market," Eurasian Economic Review, Springer;Eurasia Business and Economics Society, vol. 13(1), pages 145-173, March.
    2. Lee, Jaeram & Kang, Jangkoo & Ryu, Doojin, 2015. "Common deviation and regime-dependent dynamics in the index derivatives markets," Pacific-Basin Finance Journal, Elsevier, vol. 33(C), pages 1-22.
    3. Fung, Joseph K. W. & Mok, Henry M. K., 2003. "Early unwinding of options-futures arbitrage with bid/ask quotations and transaction prices," Global Finance Journal, Elsevier, vol. 14(2), pages 121-133, July.
    4. Zhihua Zhang & Rose Neng Lai, 2006. "Pricing efficiency and arbitrage: Hong Kong derivatives markets revisited," Applied Financial Economics, Taylor & Francis Journals, vol. 16(16), pages 1185-1198.
    5. Steven Li & Elia Alfay, 2006. "Evidence on the arbitrage efficiency of SPI index futures and options markets," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 13(1), pages 71-93, March.
    6. Steven Li & Elia Alfay, 2005. "Evidence on the arbitrage efficiency of SPI index futures and options markets," School of Economics and Finance Discussion Papers and Working Papers Series 194, School of Economics and Finance, Queensland University of Technology.
    7. Chin‐Ho Chen & Junmao Chiu & Huimin Chung, 2020. "Arbitrage opportunities, liquidity provision, and trader types in an index option market," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(3), pages 279-307, March.

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