Violations Of Put-call Parity Research Articles

Circumventing SEC Rule 201 short sale restrictions with options

This paper provides evidence on the ease and relatively low cost, relative to the potential benefits of circumventing the short selling circuit breaker regulations (SEC Rule 201) using options. Stocks with traded options react more negatively on short sale restriction trigger days relative to their counterparts without traded options. Short sale circuit breaker events are associated with increases in put and call options spreads as well as put-call parity violations. The paper estimates a discount of a synthetic short position to the prevailing stock price when Rule 201 is triggered of about 3%.

A Replicating Portfolio Approach to Valuing American Options in Closed-Form

I derive closed-form expressions for the value of American call and put options (on an asset with continuous yield) using the Feynman-Kac formula, modelling the size of early exercise premium as a function of the strike, dividend yield and time to maturity. Strategies involving European options and binary options on forwards on the asset replicate an American option exactly. Violations of Put-Call parity for American options is also explored in this framework.

The cross-market efficiency of the Italian derivatives market

PurposeThis study aims to examine the cross-market efficiency of the FTSE/MIB index options contracts traded on the Italian derivatives market (IDEM) during a period including the financial crisis between 1st October 2007 and 31st December 2012 using daily option prices.Design/methodology/approachTwo fundamental no-arbitrage conditions were tested: the lower boundary condition (LBC) and the put–call parity (PCP) condition while taking into account the role of transaction costs in mitigating the number of violations reported. Ex post tests of LBC and PCP revealed a low incidence of mispricing in this market. Furthermore, to check the robustness of the results obtained by the ex post tests, ex ante tests were applied to PCP violations occurring within a one-day lag.FindingsThe results showed a significant drop in the number of profitable arbitrage strategies. The findings obtained from all these tests generally support the cross-market efficiency of the Italian index options market during the sample period, though some violations were occasionally reported. Overall, the number and monetary value of the violations reported declined during the post-financial crisis period compared to those during the financial crisis period.Research limitations/implicationsThis study can be extended to test the relationships between arbitrage profitability and other factors such as the moneyness (in the money, out of the money, at the money) of options and the maturity of options. Options market efficiency tests can be conducted such as call and put spreads, box spreads and put/call convexities (butterfly spreads).Originality/valueThere are several factors that influenced the decision to test the Italian index options market. First, the limited number of studies conducted on this market. Second, the fact that the two main studies on this market are relatively old, which makes it interesting to test the efficiency of this market with respect to a new set of data, taking into account the introduction of the Euro and the impact of the recent financial crisis on this market and whether the market efficiency hypothesis holds during the period of crisis. Third, it is important to consider the effect of the new rules applied to this market.

Put-call parity violations and return predictability: Evidence from the 2008 short sale ban

We investigate the link between stock and options markets during the 2008 U.S. short sale ban. First, we find definitive evidence that the ban indeed caused stock overvaluation. Second, we show that the short sale ban caused a significant increase in put-call parity violations only in the direction of the short sale constraints and it significantly enhanced the stock return predictability of put-call parity violations. Third, the overvaluation is really large. A portfolio formed on the trading signal that the put-call parity violation is in the top quintile underperforms the lowest quintile portfolio by a statistically and economically significant abnormal daily return of 5.6% during the short sale ban period. We employ a novel and rigorous method of using TAQ intraday data to ensure that our high-low violation arbitrage portfolio as well as the five Fama-French factors used to estimate the abnormal returns are implementable by a hypothetical investor exempt from the shorting ban.

Put-Call Parity in Equity Options Markets: Recent Evidence

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.

An Empirical Study of the Cross Market Efficiency of the Index Options Market: A Case Study from the Italian Derivatives Market During and Post the Financial Crisis

This study examines the cross-market efficiency of the FTSE/MIB index options contracts traded on the Italian derivatives market (IDEM) between 1st October 2007 and 31st December 2012, a period including the financial crisis, using daily option prices. Two fundamental no-arbitrage conditions are tested: the lower boundary condition (LBC) and the put/call parity (PCP) condition while taking into account the role of transaction costs in mitigating the number of violations reported. Ex-post tests of LBC and PCP revealed a low incidence of mispricing in this market. Furthermore, to check the robustness of the results obtained by the ex-post tests, ex-ante tests were applied to PCP violations occurring within a one-day lag. The results showed a significant drop in the number of profitable arbitrage strategies. Overall, the number and monetary value of the violations reported declined during the post financial crisis period compared to those during the financial crisis period. The findings obtained from these tests generally support the cross-market efficiency of the Italian index options market during the sample period, though some violations were occasionally reported.

Violations of put-call parity for CNX Nifty index options: a study at National Stock Exchange

Derivatives markets provide a platform for market participants to hedge their risk, and aid price discovery. Correct pricing of derivatives instruments is imperative in the performance of these functions. In the present study, an attempt has been made to examine the valuation of CNX Nifty index options in terms of put-call parity (PCP) relationship, over a ten-year period. Since PCP is a no-arbitrage-based argument, it does not suffer from the limitations that are inevitable while gauging pricing efficiency using model-based approaches. Various error estimates, supported by non-parametric tests have been used validate our results statistically. Our findings indicate frequent violations of PCP, though the magnitude of mispricing is small. Further, the results are charted across moneyness, days-to-expiry and liquidity. The present study can be extremely important for all stakeholders, as violation of PCP leads to risk-free profitable arbitrage, which is an antithesis to efficient markets.

Violations of put-call parity for CNX Nifty index options: a study at National Stock Exchange

Violations of put-call parity for CNX Nifty index options: a study at National Stock Exchange

Option Prices and Costly Short-Selling

We provide an analysis of option prices with costly short-selling. Short-sellers incur a shorting fee to borrow stock shares from investors who do not necessarily lend all their long positions (partial lending). We incorporate costly short-selling and options market-making into the classic Black-Scholes framework and obtain unique option bid and ask prices in closed-form. Option prices represent market-makers' expected cost of hedging, and are in terms of and preserve the well-known properties of the Black-Scholes prices. Consistently with empirical evidence, we show that bid-ask spreads of typical options and apparent put-call parity violations are increasing in the shorting fee. We also find that option bid-ask spreads are decreasing in the partial lending, and the effects of costly short-selling on option bid-ask spreads are more pronounced for relatively illiquid options with lower trading activity. We then apply our model to the recent 2008 short-selling ban period and obtain implications consistent with the documented behavior of option prices of banned stocks. Finally, our quantitative analysis reveals that the effects of costly short-selling on option prices are economically significant for expensive-to-short stocks and also sheds light on the behavior of option prices and apparent mispricings of the Palm stock in 2000.

Do Options Price Predictable Patterns in Future Stock Returns? Evidence from Accounting Anomalies

We examine whether option prices correct for predictable bias in stock prices associated with accounting anomalies. Evidence from put-call parity violations suggests that they do not. Rather, option prices accurately track contemporaneous stock prices. Further analysis suggests that high costs of trading options — implied volatility premiums and transaction costs — could prevent traders from exploiting these profit opportunities. However, we find some evidence of unexploited profit opportunities of significant magnitudes, even after transaction costs, for trading strategies that sell options. Our results suggest that option prices mechanically incorporate contemporaneous stock prices, and therefore reflect the exact forms of mispricing present in stock prices.

Short-Sale Constraints and Option Trading: Evidence from Reg SHO

Examining a set of pilot stocks experiencing releases of short-sale price tests by Regulation SHO, we find a significant decrease in put volume and price pressure of options of the pilot stocks after Regulation SHO. Violations of put-call parity and information content of option trading significantly decrease after Regulation SHO. The relaxation of short-sale constraints on equity markets allows traders to switch part of their trading demand from option markets to stock markets and hence significantly affects option market quality and spot and option market relations. Thus, it is important to consider the cross-market effects of short-sale regulations.

Kospi 200 (Increase of Option Multiplier and Price Discovery in Kospi 200 Spot and Option Markets)

Korean Abstract: 본 연구는 KOSPI200 옵션의 거래승수 인상이 옵션시장의 가격발견기능에 미치는 영향을 분석한다. 풋-콜 패리티로부터 도출된 KOSPI200 내재지수와 현물지수로 구성된 벡터오차수정모형을 이용한 주요 분석결과는 다음과 같다. 첫째, 내재지수와 현물지수간 괴리도는 승수 인상 전에 비해 인상 후에 감소하여 가격형성의 효율성이 개선되었다. 둘째, 승수 인상 후 옵션시장으로부터 현물시장으로의 정보이전과 가격발견의 주도력이 강화되었다. 셋째, 인상 후 기간에 옵션시장이 가진 현물가격 발견의 주도력은 거래량이 높은 표본에서는 강하게 상승했지만, 거래량이 낮은 표본에서는 옵션가격이 현물가격 변동에 후행하는 경향을 보였다. 이러한 결과는 승수 인상으로 인한 유동성 위축에도 불구하고, 승수 인상 전까지 KOSPI200 옵션시장에서 가격발견의 효율성을 저해하는 요인으로 상당한 비중을 차지했던 투기적(노이즈) 거래가 인상 후에 급감한 결과 옵션시장의 현물가격 발견기능이 활성화된 것으로 해석할 수 있다. English Abstract: To mitigate the problems related to the excessive speculation and high participation of retail investors in the KOSPI 200 options market, the Financial Services Commission raised the option multiplier for KOSPI 200 options to KRW500,000 equal to five times prior multiplier since March 9, 2012. The implementation of new multiplier induced radical shrinkage of liquidity in KOSPI 200 options market. This paper examines the effect of the increase of option multiplier on the price discovery functions in KOSPI 200 spot and option markets. An implied KOSPI 200 index is derived from the put-call parity relationship for index options and VECM with KOSPI 200 spot and implied indexes is applied. The main results are summarized as follows: (1) the difference between the implied and spot index, which measures an arbitrage opportunity, was decreased during the period of new multiplier. This result means that the efficiency of price discovery in KOSPI 200 options market was enhanced after the increase of option multiplier. (2) The option market leads more strongly the spot market in the price discovery process during the period of new multiplier, (3) the dominant role of option market in the price discovery process is more strong in the high liquidity sample rather than the low liquidity sample, and (4) the convergence process of temporary put-call parity violations to the parity relationship is more activated during the new multiplier period, and the dominant role of option market is closely related with this convergence process. Overall the results show that increase of option multiplier positively contributes to the price discovery of KOSPI 200 options market even though sharp shrinkages in liquidity due to new multiplier.

Is there price discovery in equity options?

We use tick-by-tick quote data for 39 liquid US stocks and options on them, and we focus on events when the two markets disagree about the stock price in the sense that the option-implied stock price obtained from the put-call parity relation is inconsistent with the actual stock price. Option market quotes adjust to eliminate the disagreement, while the stock market quotes behave normally, as if there were no disagreement. The disagreement events are typically precipitated by stock price movements and display signed option volume in the direction that tends to eliminate the disagreements. These results show that option price quotes do not contain economically significant information about future stock prices beyond what is already reflected in current stock prices, i.e., no economically significant price discovery occurs in the option market. We also find no option market price discovery using a much larger sample of disagreement events based on a weaker definition of a disagreement, which verifies that the findings for the primary sample are not due to unusual or unrepresentative market behavior during the put-call parity violations.

Put-Call Parity Violations and Return Predictability: Evidence from the 2008 Short Sale Ban

We show that the 2008 short-sale ban significantly enhanced the return predictability of put-call parity violations and attribute the significant increase in violations to stock over-valuation. The top quantile put-call parity violation portfolio under-performs the lowest quantile portfolio by a risk-adjusted daily return of 2.8% during the ban period. Panel regression analysis documents that a significant increase in return predictability during the ban is more pronounced for stocks with liquid options, further corroborating our results. Our findings are robust to a number of controls aimed at alleviating concerns that other concurrent policy changes and events might be driving our results.

Another Option for Determining the Value of Corporate Votes

This paper proposes a new approach of inferring the value of voting rights attached to a stock by using options. This method might help solve the problems present in previous studies on the value of control such as endogeneity and data availability. The paper also has implications for option pricing literature. It provides a rational explanation for some of the widely documented violations of put-call parity. Using a sample of 80 US public companies intervened by activist hedge funds from 2002 to the first half of 2006 and their industry- and size-matched firms, I find that the average percentage and probability of lower-bound put-call parity violations are higher for the companies after they are attacked by hedge funds, which is consistent with the predictions of the model.

Asymmetric Violations of Put-Call Parity Under Short Sales Constraints

Asymmetric Violations of Put-Call Parity Under Short Sales Constraints

Mean Reversion Tests of Put-call Parity for Equity Index Options with Randomization and Bayesian Gibbs Sampling Viewpoint: S&P500 versus DAX

The put-call parity (PCP) is traditionally tested by examining whether arbitrage strategies earn ex post profits. These 'direct' tests of PCP caution that these violations of PCP suggest the arbitrage models are subject to significant risk due to market frictions. The previous empirical results also indicate that when market frictions are taken into account, the deviations form PCP can fluctuate within a bounded interval without giving rise to any arbitrage profit. In contrast with previous studies, we presents a model of the option price mean reverting to a function form of PCP. We employ variance ratio test to the deviations of PCP with randomization and Bayesian Gibbs sampling viewpoint in the context of a three-state Markov-switching model. The result shows that the PCP deviations from the electronic screen-traded DAX index option, which is calculated as if the dividends are reinvested in the index, displays mean reversion at long horizons. On the other hand, those deviations from the floor-traded S&P500 index option, which is not corrected for dividend payments, vary randomly.

Box Spread and Put-Call Parity Tests for the S&P 500 Index LEAPS Market

“Option pricing models are based on arbitrage, but setting up a delta-neutral position and rebalancing it continuously over an optionOs lifetime is often a difficult and costly trading strategy. Pricing violations, therefore, may not indicate significant market inefficiency, particularly given uncertainty over the volatility parameter. By contrast, put-call parity is an option price relationship that, if violated, generates a straightforward arbitrage trade that does not require rebalancing or information about volatility. Only an inefficient market would allow substantial violations of put-call parity. A box spread uses two calls and two puts, but no position in the underlying asset, to produce a similar position to that used for put-call parity arbitrage. The box spread arbitrage also is easily set up with minimal execution risk. Bharadwaj and Wiggins consider whether the market for LEAPS written on the S&P 500 index is efficient enough to preclude violations of put-call parity and the box spread pricing relationship. They find that while LEAPS puts are overpriced relative to calls about 80% of the time, the discrepancy is seldom enough to produce a reliable arbitrage profit after transaction costs. Further exploration, including trying to assess the impact of dividend uncertainty and considering a trading strategy using futures in place of the underlying cash index portfolio, does not resolve the put mispricing issue.”

Put-call parity and the informational efficiency of the German DAX-index options market

Using transaction data for options on the German stock index (DAX), we examine the informational efficiency of this relatively new options market. Because DAX options are European style and the underlying index is a performance index, we avoid problems due to dividend estimation and the assessment of the early-exercise effect, which are encountered in existing studies. Ex-post and ex-ante tests are carried out to simulate trading strategies for exploiting put-call parity violations. We find that ex-post profits diminish dramatically when the implementation of the arbitrage strategies is delayed and/or after transaction costs are accounted for. In general, however, arbitrage restrictions, which rely on short selling of the component stocks of the index, tend to be violated more severely than those relying on long positions in these stocks. Given the short-selling restrictions in Germany, these apparent arbitrage opportunities cannot be easily exploited in practice. Furthermore, the results for different subsamples suggest that traders were subject to a learning process in pricing these relatively new instruments.

Put-call parity revisited: intradaily tests in the foreign currency options market

We test exchange-traded (PHLX) German mark options for conformance to put-call parity (PCP). Puts and calls are matched to the nearest minute, and the relative impact of competing spot exchange rate sources (Reuters vs. Telerate) is assessed. We find that PCP usually holds (roughly 96% of put-call pairs), with the exception of a notable incident in the European options pits. In those instances in which PCP is violated, we find sharp intradaily and intraweekly seasonalities for American options, with disproportionate PCP violations occurring during the relatively light trading periods in early evening and on Fridays. We also conclude that the Telerate prices as recorded by the PHLX are not as accurate as the Reuters exchange rates provided by Olsen and Associates, probably because of time lags in the Telerate data.