Pricing futures options with basis risk: evidence from S&P 500 futures options

Chou-Wen Wang and Ting-Yi Wu

Applied Financial Economics, 2008, vol. 18, issue 19, 1561-1567

Abstract: This study empirically tests the performance of the Future Option model with Basis Risk (FOBR) proposed by Wang et al. (2005). The Black (1976) model is used as the competing model in this empirical test. The basis risk is the only difference between the two competing models and is therefore used to determine the existence of basis risk. The FOBR model is empirically tested using the daily data of S&P 500 call options on futures. The model outperforms Black's model due to its better prediction power. For the total sample data, the mean errors in terms of index and percentages are 0.973 and 1.0% for the FOBR model, and they are -4.468 and -27.1% for Black's model. The empirical test also supports the occurrence of basis risk in futures options on stock index by eliminating systematic moneyness and time-to-maturity biases produced by Black's model.

Date: 2008
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DOI: 10.1080/09603100701720328

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