Volatility Leadership Among Index Options

Abstract

In theoretical models, derivatives are redundant securities, which is what gives rise to pricing models based on arbitrage. Real world derivatives are not redundant, which gives rise to multiple related instruments and trading venues all based on the same underlying asset and all moving along somewhat together through time. Derivatives tied to the S&P 500 index offer a prime example. The index has spawned literally dozens of interrelated futures, options, and ETFs on both its level and also its volatility. When many S&P-related securities are trading simultaneously, the question arises of where new information enters this collection of markets first: which instruments lead and which follow along behind as prices adjust to new levels? In this article, Figlewski and Frommherz look at information leadership in both price levels and (implied) volatilities across the S&P 500 (SPX) spot market, E-mini (ES) futures and futures options, and the SPDR (SPY) exchange-traded fund and its options. For both price level and volatility, the SPY appears to be the dominant market for information flow. Among the different options, where volatility information is embedded, out of the money puts seem to contain the most new information, although out of the money calls were more important for SPX options. Contracts with very short maturity are found to lose their informational role, which passes to contracts with more time remaining to expiration.