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

Andreas Kaeck, Vincent van Kervel and Norman J. Seeger

Journal of Financial Markets, 2022, vol. 59, issue PA

Abstract: 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.

Keywords: Options; Liquidity; Price impact; Informed trading (search for similar items in EconPapers)
JEL-codes: G12 G13 G14 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finmar:v:59:y:2022:i:pa:s1386418121000550

DOI: 10.1016/j.finmar.2021.100675

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