Abstract
There have been various studies of potential violations of put-call parity in US equity options markets, and the purpose of this study is to examine one potential explanation of these anomalous results. Cremers and Weinbaum [1] indicate a potential trading strategy that can obtain excess returns of up to 50 basis points per week, which is quite remarkable. However, none of these studies consider the fact that options markets have historically maintained different trading hours than those of their underlying security markets. While the US stock market has traditionally closed at 3:00 PM CST, options markets have variously closed between 3:10 and 3:02 PM CST over the past two decades. Using over ten million individual options implied volatility estimations since 1996, it is documented that these anomalies have all but disappeared since stock and option markets synchronized their trading hours. Beginning in the late 1990’s, stock prices often move slightly or to a larger degree in “after-hours” trading, enabled by the advent of electronic trading platforms. Options markets that are still open may adjust to subsequent stock market movements, although closing stock prices are reported as of 3:00 PM CST. Prior studies may have ignored these effects, and this is the first study to indicate that apparent deviations from put-call parity have decreased markedly over recent years, if they were ever economically significant at all.
Highlights
As stated in Cremers and Weinbaum [1], “Put-call parity is one of the simplest and best-known no-arbitrage relations
For a short time in the sample period under study, options markets closed at 3:10 PM CST, but that practice ended on June 23, 1997, when the closing time was changed to 3:02 PM CST
It should be noted that market participants often assume a 1.50% bid/ask spread in option implied volatilities, which would almost fully negate any potential gains from a strategy attempting to capitalize on potential “violations” of put-call parity
Summary
As stated in Cremers and Weinbaum [1], “Put-call parity is one of the simplest and best-known no-arbitrage relations. S + P = C + Ke−rT where S equals the current stock price, P equals a particular strike price and maturity of a put option, C equals the equivalent strike price and maturity of a call option, and Ke−rT equals the present value of the strike price using the risk-free rate and time to maturity in years If this relation is violated, potential arbitrage opportunities exist in the absence of transactions costs and/or a bid/ask spread. Cremers and Weinbaum [1], they find that differences in call and put implied volatilities create potential opportunities for excess profits They do not consider the effects of “after hours” trading, which became prevalent during the late 1990’s, via online the earliest electronic trading networks such as Instinet, Island, and NYSE Arca. Over the past three decades, options markets have alternatively closed at 3:10, 3:02, and 3:00 CST, which may have created the appearance of arbitrage profits that did not really exist
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