Price impact versus bid-ask spreads in the index option market

Kaeck, Andreas, van Kervel, Vincent and Seeger, Norman J (2021) Price impact versus bid-ask spreads in the index option market. Journal of Financial Markets. a100675 1-22. ISSN 1386-4181

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We investigate the puzzle of why bid-ask spreads of options are so large by focussing on the price impact component of the spread. We propose a structural vector autoregressive model for trades in the option market to analyze whether they move the underlying price and/or the underlying’s volatility. Our model captures cross-option strategies by pooling order flows across contracts after a decomposition into exposure to the underlying asset and its volatility. While our estimates confirm that S&P500 option trades indeed significantly move the underlying and the volatility, the economic magnitudes are very small. Hence, large bid-ask spreads of options remain a puzzle.

Item Type: Article
Schools and Departments: University of Sussex Business School > Accounting and Finance
SWORD Depositor: Mx Elements Account
Depositing User: Mx Elements Account
Date Deposited: 20 Sep 2021 07:30
Last Modified: 13 Oct 2021 09:45

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