Utilization of Weekly Options for the Improvement of the Volatility Index

Abstract

As the liquidity of KOSPI 200 index options is concentrated on the nearest expiration contract, the V-KOSPI 200 index, which is based on near- and next-term months options, fluctuates abnormally, and the designated market makers of V-KOSPI 200 futures suffer from hedging their inventory positions. This study suggests the volatility index, which includes KOSPI 200 weekly options instead of next-term monthly options. The index can mitigate rare spikes and the low volatility of the V-KOSPI 200 index, which mainly arise from stale market prices and low-frequency trading in the second and third contract months. The empirical results show that the monthly trading volume of weekly options more than triples compared to second- and third-contract month options, and the microstructure of both markets is roughly similar. The trading frequency of weekly options is six times higher than that of next-term monthly options. Therefore, V-KOSPI 200 futures market makers can use weekly options traded more actively instead of second-month options as components of hedging portfolios, while helping the new volatility index mitigate the abnormal fluctuation of the V-KOSPI 200 index.