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Co-movements of Index Options and Futures Quotes

Author

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  • Fahlenbrach, Rudiger

    (Ohio State U)

  • Sandas, Patrik

    (U of Virginia)

Abstract

We re-examine the co-movements of index options and futures quotes first studied in Bakshi, Cao, and Chen (2000). We show that the frequency of quote co-movements that are inconsistent with standard option pricing models is significantly higher around option trades. We examine empirically two explanations for these co-movements. First, we show that in simulations the stochastic volatility model can generate approximately the right frequency of inconsistent co-movements when its parameters are chosen to match observed option prices. But even allowing for different regimes in trade and no-trade periods the model generates virtually the same frequency of inconsistent co-movements. Second, we examine the quote co-movements in event-time around trades and show that they are consistent with either traders picking off stale option quotes or with traders submitting aggressive limit orders. Our evidence suggest that inconsistent co-movements reflect both departures from the univariate diffusion model and market microstructure frictions.

Suggested Citation

  • Fahlenbrach, Rudiger & Sandas, Patrik, 2005. "Co-movements of Index Options and Futures Quotes," Working Paper Series 2006-2, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    • Handle: RePEc:ecl:ohidic:2006-2
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    References listed on IDEAS

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    1. Gondzio, Jacek & Kouwenberg, Roy & Vorst, Ton, 2003. "Hedging options under transaction costs and stochastic volatility," Journal of Economic Dynamics and Control, Elsevier, vol. 27(6), pages 1045-1068, April.
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    Cited by:

    1. Shailesh Rastogi & Chaitaly Athaley, 2019. "Volatility Integration in Spot, Futures and Options Markets: A Regulatory Perspective," JRFM, MDPI, vol. 12(2), pages 1-15, June.

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